CHAPTER 5 CONSTITUTIONAL VERSUS CONTRACTUAL COMMITMENTS BY GOVERNMENTS
| Jurisdiction | United States |
(Feb 1995)
CONSTITUTIONAL VERSUS CONTRACTUAL COMMITMENTS BY GOVERNMENTS
Cox Buchanan & Padmore
Denver, Colorado
When governments wish to attract new mineral investments, one way they do so is by agreeing to provide fixed, long term assurances of the rights, duties and benefits that the mineral company will obtain from future mineral projects. The purpose of such assurances is to induce the mineral company to invest by reducing the risk that once the investment has been made, a commercial find has been identified and operations have commenced, the government would either cancel the rights granted or so change the fiscal terms applicable to the project as to make it uneconomic.
The more highly industrialized countries tend to provide fewer such assurances to mineral companies. They often have a well-developed mineral industry that is substantially owned and operated by nationals of the country. For that reason, mineral companies in such countries have more ability to participate in and influence the political process in order to protect their interests. By contrast, in many less industrialized or developing countries, foreign owned companies comprise the sole or greatest source of investment in minerals. They have little political clout and, being foreign enclaves, are particularly vulnerable targets for governmental action.
At present, many developing countries are actively seeking new foreign mineral investments. During the past decade, many have changed applicable laws governing mineral rights, the development and exploitation of minerals and the taxation of mineral projects in order to make such investments more attractive. However, successful projects often lead to changes in attitudes. Nationalistic sentiments may grow stronger as people begin to feel that foreign interests not only control national mineral wealth but, to their great profit, are extracting an irreplaceable natural resource.
Mineral investments by foreigners often appear to be a mixed blessing to the citizens of the host country, bringing jobs and enhanced economic activity, but also disrupting social patterns and, more evidently and importantly, the natural environment. In a society that needs the jobs and economic activity that mineral investment may bring, the balance will tilt decisively in favor of doing what is necessary in a competitive world to attract such investments. Invariably, however, this approach will eventually be replaced by negative feelings and second thoughts. These provide fertile ground for politicians, and the foreign project may become a lightning rod for the myriad social and ethnic tensions that accompany economic development and social change.
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In any event, the predictable occurrence of a cyclical development in which nationalism bred of hostility and suspicion may replace the earlier eagerness to encourage mineral investments perhaps best explains the stubbornness with which so many governments insist upon obtaining a stake, typically a carried interest of some kind, in the mineral project. A government's interest in a project does not improve, and indeed may reduce, its ability to obtain revenues from the project. Whenever, directly or indirectly, the government reduces the royalties or profit taxes it might otherwise receive in order to obtain an equity interest, it gives up a source of revenue which it controls as sovereign for one subject to the collective decisions of its fellow shareholders or co-venturers. If one assumes that a prudent investor will only invest initially, and continue to invest in future, in a mineral project from which a certain minimum return can be expected, then such an investor will merely add the government's equity take to all those other taxes, fees and assessments imposed on the project in order to determine if the investment is worth making. If that decision is affirmative despite a government equity participation of, say, fifteen percent, then presumably the same decision would have been made had an equivalent tax, rather than an equity stake, been demanded by the government. Indeed, because a tax credit from its own domestic government might be available for taxes but not dividends paid a foreign state, the mineral investor might even accept a somewhat higher tax.
The government can obtain the right to sit on management committees or boards of directors, or to form special joint oversight committees by statute or agreement. To obtain equity either for this purpose, or in order to acquire information about the mineral operations in question is unnecessary. What really is at stake, I believe, is the almost instinctive need by governments to mitigate the nationalistic concerns of the people in a symbolic way, and to assure them that collectively they will have a role to play in the venture. This symbolic equity should be recognized as just that. Governments should not confuse this quite separate need with their interest in obtaining a revenue stream from mineral projects.
Thirty years ago, governments sought control over mineral projects within their borders. The more moderate approach was to obtain a majority or controlling interest. In many cases, outright nationalization occurred. Decades later, with the notable exception of many oil producing states, the cycle has turned. Total or majority control often shut off the capital and technology needed to assure a stream of new projects. Management difficulties, exacerbated by the effect of political considerations, has recently convinced many governments to forego that role. State mineral corporations are now nearly universally scorned. The need for new mineral investment has silenced the old debate about permanent sovereignty over minerals, and given
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rise to a strong concern with attracting scarce capital in a competitive environment. Thirty years ago, many governments of developing countries defined the challenges facing them to be controlling large multinational companies, changing the one sided terms under which minerals within their borders were being exploited, and taking advantage of what they perceived to be a long term realignment of economic power towards the developing countries with their rich natural resources and away from the dominant industrialized countries. The challenge now, by contrast, is in the competition for scarce capital.
Still, once the investment has been made, the government gains leverage because the project is in place and is in its territory. The temptation to obtain a larger share of revenue from a now "captive" entity that has little or no domestic political clout is strong. That impulse may also be heightened by a sense of righteous national purpose if, as is often the case, people of the country reassess the project terms previously granted the mineral company and come to believe that the terms may have included needless giveaways, perhaps the result of corrupt favors granted prior officials. Of course, the concern that extreme action may dry up future investment, or that bilateral ties with the home government of the mineral company may be adversely affected, or even that financial institutions with project loans may reassess future extensions of credit may act as a restraint on the government.
Mineral companies and their counsel try to resolve this problem by obtaining a contractual commitment from host governments covering the most important aspects of a project such as fiscal requirements and the assurance of secure tenure rights. The mineral company may obtain a "stabilization" clause that ostensibly forbids unilateral changes to, or "freezes," those tax provisions that are applicable to the mineral company. A dilemma arises from all these efforts. It is whether or not a government can, by binding promise or contract with a foreign private entity that is subject to its jurisdiction, restrict its ability to do those things that are normal incidents of sovereignty. For example, may it bind itself to obtain only certain enumerated taxes from the mineral company at specifically determined rates? Is such a commitment binding on future governments for its entire term? More fundamentally, to what body of law should one look to obtain the answer? If it is the domestic law of that country, then cannot the rights of the mineral companies be extinguished by legislative act or executive fiat?1
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The Legal Debate — Pacta Sunt Servanda and Rebus Sic Stantibus
The approach to resolving these issues has in the past relied heavily upon theoretical constructs borrowed from the law of treaties between nation states. Thus, affected companies have asserted that, as a matter of international law, the doctrine of pacta sunt servanda, which upholds the binding nature of treaties and, by analogy, contracts between states and private entities, should control. Governments of developing countries, seeking to escape one-sided or onerous contracts, or to obtain greater benefits from highly lucrative projects, have argued either that pacta sunt servanda is inapplicable or that it is not absolute. They have asserted that the state's duty to pursue the public welfare gives it an inherent and inalienable right unilaterally to amend, modify or rescind agreements. Furthermore, the state's exercise of that duty cannot be, consistent with basic notions of sovereignty, subject to review by foreign judicial or arbitral tribunals. The doctrine of rebus sic stantibus which, even as regards treaties between nation states, sets forth the right of one state to make changes to a treaty in the face of certain unanticipated circumstances...
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