CHAPTER 12 A SUCCESSION OF PARTIES: WHEN DOES A STATE SUCCESSION TERMINATE A CONTRACT?
| Jurisdiction | United States |
(Apr 2015)
A SUCCESSION OF PARTIES: WHEN DOES A STATE SUCCESSION TERMINATE A CONTRACT?
Senior Legal Counsel
Shell International B.V.
The Hague
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REG FOWLER is Senior Legal Counsel at Shell in the Hague. Having qualified in English law at the London law firm Clyde & Co., he has worked in house for 3 different oil companies over the last 19 years, in trading and shipping as well as upstream joint ventures. His present responsibilities cover Shell's non-operated joint ventures in Kazakhstan and western Russia as well as providing training and advice on joint venture governance and agreements to lawyers and clients in Shell. He also publishes and presents outside Shell on topics including joint venture agreements, oil cargo documentation, host government contracts, and the Arctic.
Summary
Changes in governments and the overthrow of States are increasingly commonplace. Drafters of long term contracts with Sovereign States, be they loan agreements or natural resources or infrastructure investment agreements, ought to understand the legal principles that define when, following a succession, a successor State is bound by previous contracts and when it is not. No widely applicable principle emerged from the State successions at the end of the colonial period. Professor Cheng has studied the successions following the end of the Soviet Union and concludes that in practice, the outcome of successions can be predicted by understanding the forces at work in a succession. He challenges lawyers to give realistic advice on how State successions may play out and how a long term contract may best be drafted and managed to survive a succession. This paper ambitiously takes up that challenge and offers some initial suggestions.
Introduction; recognising the limits of contractual obligations on States
The 2008 economic crisis was the ultimate testing ground of lawyers' favourite tools for counter-party credit control. Until then, lawyers advising in financial and commodity marketsconsidered that a liquidator's right to disown non-performing or expensive contracts of an insolvent entity could be defeated by entering into a master netting agreement, which required trading counterparties to treat their individual trades in the market as a single agreement. Thus "cherry picking" could be contractually defeated and credit exposures treated as the net product of all trades, marked to market. Then just as single agreement clauses were apparently proving their worth, EU legislators introduced legislation to enable the debts of insolvent commercial banks to be re-packaged into loss-making and profitable categories and potentially transferred to different entities - a form of asset ring-fencing.1 The very essence and attraction of netting for the banks' creditors were eliminated, since a creditor could no longer be sure of offsetting a credit exposure under one trade with a debt under another trade simply because the trades could be split between different entities on insolvency.
Two years previously a professor of international law at the International Law Center of the New York Law School Tai-Heng Cheng published "State Succession and Commercial Obligations".2 The book addresses a vitally important question for all commercial lawyers advising a client negotiating or potentially litigating a long term contract with a Sovereign State. Simply put, what happens to such a contract when the State as counterparty changes? After all, it is so easy to focus one's attention on the clauses one believes matter in State contracts - the waiver of sovereign immunity, warranties of authority and consents, stabilisation and dispute resolution. It is prudent to consider a State's creditworthiness and perhaps try one's luck at negotiating for some form of credit protection or collateral. True, a State cannot be liquidated as if it were a commercial corporate entity. But inserting a
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change of control clause into a State contract would seem odd to the say the least. But then again, maybe not....
The messages of Cheng's book for commercial lawyers are very clear. Firstly, with the end of the Cold War, the frequency of State successions has increased remarkably, as popular movements for political change have been allowed to achieve their aspirations, unrestrained by one or other superpower. Secondly Cheng shows how the legal principles deployed by international public law specialists to explain and manage State successions in the twentieth century no longer explain modern State Succession, if they ever did. Still more disconcerting for clients, Cheng argues that the traditional distinction between State succession and change of Government also fails adequately to identify cases of political upheaval when a State's commercial obligations may be subject to challenge, renegotiation and even repudiation, and cases when they are not. He defines State succession with a necessary degree of circularity -
"any fundamental reorganization of a state that triggers international claims concerning preexisting commercial obligations and requires an international response" 3
A survey of the late twentieth century political change defeats any attempt to find a sensible predictive pattern in terms of what characterises a State succession. The Iran Claims tribunal rejected the argument that the fall of the Shah in 1977 constituted a sufficiently drastic change in Iran's government that the previous regime's commercial debts could be treated as no longer binding on the successor.4 However several planned and non-contentious State successions such as the separation of the Czech and Slovak republics in 1993 and the return of Hong Kong and Macao to the People's Republic of China each involved a rational review of each party's existing treaties and debts, and in some cases renegotiation or termination.5
In 1967, the United Nations set the International Law Commission ("ILC") the task to draft two treaties, a Convention on the Succession of States in respect of Treaties, and a Convention on the Succession of States in respect of State Property, Archives and Debts, in the hope of codifying international public law rules on the subject. The resulting Conventions did not meet the target. The Convention on State Property, Archives and Debts 1983 has been ratified by only 7 States and has not come into force. The Convention on State Succession in respect of Treaties 1978 is in force but has been ratified by only 22 States, none of whom are major powers. The deliberations of the ILC in preparing the drafts were driven by the political concerns of the negotiators at the time; the negotiations were heavily influenced by the concerns of newly independent states keen to protect the interests of other colonies seeking independence. Even from the outset, the participants discovered that they could not agree upon acceptable definitions of a change of government which should have no effect on a State's commercial obligations, and a State succession where the point was properly open for debate -so even that
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preliminary issue was left unresolved.6 None of the doctrines on State succession previously advocated7 was widely accepted, leading to a politicised debate in which former colonial powers and newly independent states deployed policy considerations, not legal principles.
This had significant impacts on the 1978 Convention; firstly, it prescribes that terms of a treaty between States which expressly provide that obligations should survive a succession do not in fact bind a successor- so that newly independent states could repudiate any oppressive terms imposed on them by the departing colonial power.8 Secondly, the Convention did not resolve the question whether treaty rights and obligations were extinguished by a State succession save in relation to newly independent States, which are freed from all the predecessor's treaties and in cases where a new State separates from another. In the case of independence, the Convention adopted the "clean slate" principle. Somewhat illogically, the Convention provides for treaty obligations to survive a State succession and to bind a successor State where the successor State separates from the predecessor State which survives in respect of a diminished territory.9 Lastly, and perhaps unsurprisingly, states in the developed world did not sign (save for Estonia and the Czech Republic). The 1978 Convention was anachronistic, after its time, too late to affect the last few independence movements but in time to cause problems for State successions that were not the product of decolonisation.
More to the point, the 1978 Convention applies only to international obligations governed by international law between States and is not immediately applicable to commercial obligations. Since the 1978 Convention came into force, two arbitrations have considered whether Bilateral Investment Treaties bind successor States. Both involved the separation of the Czech and Slovak Republics and both decided they did bind the successor States, without expressly relying on the 1978 Convention.10 In deliberating the 1978 and 1983 Treaties, the international legal community could not agree on a comprehensive set of rules to define when a State succession did and did not terminate or allow the termination of a State's treaty obligations, still less its commercial obligations. The analogy with insolvency law is appropriate here on two levels - firstly, until 2008, there was growing international consensus as to the legal rules defining when a liquidator of an insolvent entity can and cannot treat such entity's commercial obligations as no longer binding upon it or its assets. In general terms, the desire to contain the impact of an insolvency on counterparties in financial markets outweighed the desirability of maximising the value of...
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