Renegotiation and adaptation of international investment contracts: the role of contract drafters and arbitrators.

AuthorBerger, Klaus Peter

"Renegotiation should ... be acknowledged as an integral feature of the foreign investment process." (1)

TABLE OF CONTENTS I. INTRODUCTION II. CONTRACT WITHOUT RENEGOTIATION CLAUSE A. Force Majeure Clauses and the Hardship Concept B. Inherent Obligation to Renegotiate? III. CONTRACT WITH RENEGOTIATION CLAUSE A. Examples from Legal Practice 1. The AMINOIL Clause 2. The Ok Tedi Clause 3. The Ghana/Shell Clause 4. The Lasmo Clause 5. The Qatar Clause B. Similarities and Differences C. Definition of "Trigger Events" D. The Parties' Obligations in Reaching Agreement 1. General Obligations During Negotiations 2. Duty to Negotiate or Duty to Agree? E. Claims for Damages F. Procedural Enforceability 1. The Significance of Arbitration 2. Differences about Contractual Adaptation as "Legal Disputes"? a. Non-doubtful Cases b. Doubtful Cases 3. The Traditional "Dispute Oriented" Understanding of Arbitration 4. Arbitration as a Means of Contract Adjustment a. Procedural Law b. Contract Law: Sanctity of Contracts vs. Fairness IV. SUMMARY I. INTRODUCTION

In modern-day international investment practice, especially in connection with the exploitation of natural resources, Production Sharing Agreements have come to take over the role of the classic concession agreement. (2) Like their predecessors, these contracts are particularly vulnerable to disturbances in the commercial balance agreed to, or assumed by, the parties at the conclusion of the contract. (3) This vulnerability has three primary causes.

First, these are classic examples of long term contracts. In the petroleum industry, the commitment of significant capital for exploration, particularly in development, and the assumption of considerable risk, particularly in exploration, require contracts covering up to and over ten years of exploration, and over twenty years of an initial production phase. (4) The long duration of these contracts makes them particularly susceptible to political or economic influences which are unforeseeable at the time of contract conclusion, but which from the investor's point of view have a negative effect on the economic equilibrium of the contract.

Second, the investor will initially incur significant costs in setting the exploration strategy in motion (sunk costs), which will only be recovered over the duration of the contract. The investor therefore unavoidably depends on the contract actually being carried out for the length of time and on the basis of the framework initially negotiated with the host country.

Third, many host countries make use of the investor's "prisoner's dilemma," pressing for changes to the originally negotiated equilibrium in their favor once the venture has begun, i.e. once the investor has a large amount of sunk costs at stake. In particular, this is likely where exploration plans have proven to be more profitable than originally expected. These negative changes in the investment climate occur through amendments to the relevant laws, tax increases or a more or less forced renegotiation of the contract (obsolescing bargaining): (5)

As soon as a commercially valuable mineral is developed, the psychology of the government is altered. The company may begin to enjoy a high return on its investment. The government ... may begin to feel that the resource is virtually being given away. The stage is set for renegotiation, as the original risks are forgotten. Usually the old terms are modified and the parties adopt new terms that are more favourable to the government than those agreed to under conditions of relative uncertainty. (6) In addition to these conscious and controlled influences such changes can also result from deterioration in the general economic or political circumstances in the host country not foreseen at the time of concluding the contract. For the investor, both scenarios are equally problematic: profit and profitability estimates based on the contractual equilibrium will not be met and the economic success of the project is jeopardized.

This article will examine ways to protect the investor against these sorts of risks and uncertainties. Two scenarios need to be distinguished. (7) In the first scenario discussed infra in Section II, the contract contains no specific adjustment or renegotiation clause. In the second scenario, discussed infra in Section III, the parties have included special provisions in their contract to deal with these cases.

  1. CONTRACT WITHOUT RENEGOTIATION CLAUSE

    If the parties have not included special mechanisms for dealing with a change in the commercial equilibrium in their contract, a renegotiation or adjustment of the contract to changed circumstances can be considered only where other contractual terms or the applicable law provide an appropriate starting point. (8)

    1. Force Majeure Clauses and the Hardship Concept

      In cases where there is no express renegotiation clause, investors frequently rely on either a force majeure clause included in the contract or the hardship concept of international contract law. (9) For example, the Lasmo Group Production Sharing Contract of August 19, 1992 between "Vietnam National Oil and Gas Corporation of the Socialist Republic of Vietnam, Lasmo Vietnam Ltd. & C. Itoh Energy Development Co., Ltd for Offshore Block 04-2" contains the following force majeure clause:

      17.7 Force Majeure The obligations of each of the Parties hereunder, other than the obligation to make payments of money, shall be suspended during a period of Force Majeure and the term of the relevant period or phase of this Agreement shall be extended for a time equivalent to the period of Force Majeure situation. In the event of Force Majeure the Party affected thereby shall give notice thereof to the other Party as soon as reasonably practical stating the starting date and the extent of such suspension of obligations and the cause thereof. A Party whose obligations have been suspended as aforesaid shall resume the performance of such obligations as soon as reasonably practical after the removal of the Force Majeure and shall notify the other Party accordingly. The UNIDROIT Principles of International Commercial Contracts as a restatement of the currently accepted rules and principles of international contract law (10) define hardship and its legal consequences as follows:

      Article 6.2.2 - Definition of Hardship

      There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished, and

      (a) the events occur or become known to the disadvantaged party after the conclusion of the contract;

      (b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;

      (c) the events are beyond the control of the disadvantaged party; and

      (d) the risk of the events was not assumed by the disadvantaged party.

      Article 6.2.3 - Effects of Hardship

      (1) In case of hardship the disadvantaged party is entitled to request renegotiations. The request shall be made without undue delay and shall indicate the grounds on which it is based.

      (2) The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.

      (3) Upon failure to reach agreement within a reasonable time either party may resort to the court.

      (4) If the court finds hardship it may, if reasonable,

      (a) terminate the contract at a date and on terms to be fixed; or

      (b) adapt the contract with a view to restoring its equilibrium. (11)

      These examples show that force majeure clauses usually provide for an extension of the contractual performance period and the cancellation of the contract as a measure of last resort. (12) They serve primarily as precautions against the risks posed by economic, political or social events (13) unforeseeable at the time contracting, though without the aim of ensuring or re-establishing the commercial equilibrium of the contract. However, force majeure clauses can also contain an obligation on the parties to negotiate and to search for ways to overcome the situation resulting from intervention by "acts of god." Such a contract is particularly ill-suited for cancellation due to the complexity and financial obligations already incurred by the parties. (14) The hardship concept, in comparison, aims directly at maintaining the commercial equilibrium of the contract in that it is triggered when the burden posed on one party has reached the "limit of sacrifice." As a legal consequence of hardship, the parties are obliged to renegotiate their contractual relationship. (15) Thus, the hardship concept proves to be a special form of the same idea incorporated in renegotiation clauses: making contractual obligations more flexible in light of alterations to the commercial equilibrium. (16)

      Although both the hardship concept and the force majeure clauses can, in theory, provide a starting point for the renegotiation of the contract in case of changed circumstances, this is rarely the case in practice. If the host country asserts a hardship or force majeure event which it brought about itself (legislation), it cannot rely on the clause even when the contract was not made with the state directly, but instead with a government corporation, as is common in natural resources exploration. These corporations are denied reliance on the contractual force majeure clause because, in a fashion similar to piercing the corporate veil, they are regarded as an integral component of the state, which is responsible for the change of conditions in the host country. (17)

      If the investor asserts a hardship or force majeure event, they will likewise only rarely be able to achieve a renegotiation of the contract. Should the parties fail to reach an agreement upon renegotiation, their dispute must be decided before an international arbitral tribunal upon which the parties will...

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