By Liang Peng
The renegotiation clause is common in international investment contracts, especially in natural resources sector. Due to the long term nature of international investment contracts, unforeseen situations are likely to happen, breaking the economic equilibrium of the contracting parties, even destroying the contractual relationships between the parties. The renegotiation clause provides a legal mechanism for the parties to adjust the contract terms and restore the economic equilibrium set up when the contract signed.
Yet, not all renegotiation goes smoothly, and often disputes over the negotiation process make the renegotiation between parties deadlock, or fail with the consequence of contract termination. Therefore, a third party solution is needed, i.e. arbitration. What is the role of the arbitrator in disputes over the renegotiation clause? How should the tribunal function to achieve the economic equilibrium of the contractual parties?
This article focuses on the function of arbitral tribunal as to the renegotiation clauses. It firstly reviews the nature of the renegotiation clauses, and the disputes over the renegotiation clauses in international arbitration practice. And then points out the most controversial aspect of renegotiation disputes—the consequences of a failure to reach an agreement. The question brings in a deliberate analysis on the relationship between the effectiveness of renegotiation clauses and the power of arbitral tribunal. The problems lie in the adaption of ongoing contracts and compensation to affected parties. It concludes that request for adapting ongoing contract by third party in renegotiation does exist, and renegotiation clauses clearly providing the arbitral tribunal power to adapt ongoing contract are enforceable under most legal systems and effective to restore economic equilibrium.
Due to the high risk exposure of international investments, the long-term nature of such contracts makes them vulnerable to some unforeseen situations. Such events may make the investments unprofitable for investors, inoperative to perform for both parties and the economic interests between the parties could be unbalanced. One consequence of such events is for the parties to consider termination of the contract. But, it’s not usually the best solution for the parties.
The Renegotiation clause is common in the long-term international investment contracts, particularly in the natural resources and energy sectors. [1] It provides a mechanism for the parties to adapt the contract in order to restore the economic equilibrium between them without ruining the relationship between the parties.
The renegotiation clause does not go smoothly in practice. The disputes over the renegotiation clause often arise from the openness, vagueness and silence of its wording. These disputes may lie in the trigger event, the renegotiation obligation, and the consequences of a failure to reach an agreement. Parties to international investment contracts often resort to international arbitration to solve them. Among the disputes, the first two aspects focus on the proper process for renegotiation, the last one emphasizes on the substantive result of renegotiation. The possible consequences of a failure to reach an agreement may be adaptation of ongoing contract, termination of the contract and compensation for the aggrieved party. Although adapting the contract may be effective to restore economic equilibrium, it is contrary to the common recognized principle of Sanctity of Contract. Through case study, it can be found the arbitral tribunal is unlikely to adapt ongoing contracts with only few exceptions. This article focuses on the function of the renegotiation clause through establishing the concept of the economic equilibrium, and discusses how the renegotiation clause and the arbitration should go together to realize the function of the renegotiation clause.
Renegotiation Clauses in International Investment Contracts
Renegotiation
“Experience…indicates…movement towards increased national benefits and increased national control of oil operations, Therefore it is recommended that the U.S government should urge oil companies to include in concession contracts provisions calling for renegotiation of financial clauses every five to ten years…and...the adoption of general legislation rather than negotiated contracts” [2]
Since 1960s, the decolonization in combination with a discussion on the new economic order and permanent sovereignty of natural resources, the debt crises in Middle and South America, the fall of communism and the Asian crisis all demonstrate the function of renegotiation as an important method to save international investment contracts. Because, these situations make contracts inoperative or unfair to one of contracting parties, breaking the balance of interests. Although the parties may choose to terminate the contracts, most of the time, the capital intensive projects in these industries can not easily be stopped. Furthermore, from the point of view of the HC, the termination of the contract by the foreign investors would be a bad record for any other investment of the same investors in the future, and vice versa. Therefore, renegotiation becomes for both parties, a way to avert risks without ruining the benefits of the contractual relationship.
Renegotiation is known to all major legal systems. Most major legal systems (with reservations, in particular, for English common-law) recognize a right/duty to renegotiate obligations for ongoing performance in a long-term commercial contract when, due to an unforeseen fundamental change of the major circumstances underlying an agreement, the continuation of ongoing performances under the contract would severely disrupt the originally negotiated contractual equilibrium and make continuation of performance excessively onerous to one party. Contracting practice and commercial practice of de facto renegotiation confirms that in international business there is an expectation that parties should not be held to continue a performance which would be excessively onerous due to such change of fundamental circumstances. Many contracts provide explicitly for such a renegotiation procedure named as ” renegotiation clause”, in other agreements, parties renegotiate based on such generally recognized principles and on the basis of contracting freedom. [3]
In summary, we can observe from history that renegotiation is born to help the parties restore the economic equilibrium damaged by some drastic changes affecting the contractual circumstances. The economic equilibrium of a contract means the balancing of the economic core of the contract which is the mutual intention of the parties when the contract signed. This principle can be seen in many model contracts in natural resources sector, such as the Model PSA of the Kurdistan Regional Government (KRG), PSCs of the Vietnam, etc.
The renegotiation clause is often seen in international investment contracts as one of legal methods of renegotiation. It provides a mechanism to change originally agreed terms, in particular the price, or even leave certain issues open to be agreed at a later time when the necessary information is available.[4] In light of party autonomy, renegotiation clauses may take any form ranging from fixed and automatic adaptations of the price according to an elaborated formula, to very wide renegotiation clauses where it is neither specified which contractual rights and duties are to be amended nor in which way.
The former can be found in the Concession Agreement between the State of Kuwait and Aminoil, Art 9:
‘ If , as a result of changes in the terms of concessions now in existence or as a result of the terms of concessions granted hereafter, an increase in benefits to Governments in the Middle East should come generally to be received by them, the Company shall consult with the Ruler whether in the light of all relevant circumstances, including the conditions in which operations are carried out, and taking into account all payments made, any alternations in the terms of the agreements between the Ruler and the Company would be equitable to the parties.’
The latter types of renegotiation clauses differ from these limited renegotiations clauses by their much broader ambit; in so far as they neither describe the triggering event nor the potential ambit of renegotiations in any further detail. The problems of the wide renegotiation clauses are the same as the former as to the result of a failure to reach an agreement. An example can be found in the OK Tedi Papua New Guinea Concession Agreement of 1976 which contains the following brief and very general clause:
“The parties may from time to time by agreement in writing add to, substitute for, cancel or vary all or any of the provision of this Agreement[6]
The reasons for this lie in the unpredictable result of the performance of the contract. And also, it is very difficult to formulate a general renegotiation clause which defines specifically when a change of circumstance and its impact is serious enough to trigger a renegotiation. [7]
In other fields of international commercial transactions, special “hardship” clauses have developed which enable a party to request an adaptation of contract terms if continued performance would become unduly and excessively onerous. Hardship situations may be due to various causes-natural (earthquake, flood) or economic (price fluctuations) The idea again is that a contract should not, because of a major change in important circumstances, force a party to continue to operate at a loss, since this would destroy the benefit both parties should expect form the continued operation of a long –term contract. [8] It’s not easy to distinguish between renegotiation clauses and hardship clauses; often, the hardship clause is regarded as one type of renegotiation clauses.[9]
The Structure of the Renegotiation Clause
(1) Trigger event. This could be a specific date at which the review of the existing clauses is going to take place or a particular change of circumstance. In hardship clauses, they often provide examples of which events and what additional burden constitutes hardship together with very broad definition of it.
(2) Content of the obligation to negotiate. Most clauses merely state that the parties should engage in negotiation. Details regarding which steps and action this negotiation obligation entails for the parties are generally not given. In particular in common law countries this lack of specificity has led courts to consider such agreement to be unenforceable “agreements to agree”.[10]
(3) The consequences of a failure to reach an agreement. This is the most problematic issue in practice. Very often, the parties do not provide explicit statement as to the consequences of not reaching an agreement to adaptation. Will the contract as a result stay as it is, will it be terminated and at what terms, or will it be adapted by a third party, such as a national court or arbitration tribunal? [11]This depends primarily on the interpretation of the renegotiation clause. In international investment contracts, such duty often relies on the international arbitration tribunal. One of the crucial issues in this respect is whether the clause only entails an obligation to negotiate in good faith or whether it also gives rise to an obligation to adapt the contract. These questions need to be decided by arbitral tribunal in the context of renegotiation clauses. However, this is an important part of the renegotiation clause to make the renegotiation effective, i.e. to achieve restoration of economic equilibrium.
NUTSHELL:
This is a tricky one. They say that the devil is always in the details; this is particularly apt when it comes to mountains of legal documents that pile up when complex transactions arise. It will interest some people to know that some lawyers make their bread and butter by looking for and exploiting or plugging loopholes in contracts. With respect to International investment contracts in the natural resources sector it goes without saying that negligence in examination of contracts has very expensive consequences. Liang has - in this article- shown us that renegotiation clauses are a proactive route to securing economic interests of all parties to a contract. Economic disequilibrium will always rear its unpleasant head; however properly structured renegotiation contracts can save the day; this is not to suggest that disagreements do not take place. In his next article, Liang will address disputes over the renegotiation clause and consequences of failures to reach an agreement. For more information on this article and to view Liang's professional profile and his other articles, click here.-->
[1] Thomas Waelde, Abba Kolo., Renegotiation and Contract Adaption in the International Investment Projects:
Applicable Legal Principles & Industry Practices, in Oil, Gas and Energy Intelligence, Vol.1,(2003) p1.
[2] Claude Duval, Honore Le Leuch, Andre Pertuzio, Jacqueline Lang Weaver, International Petroleum Exploration and Exploitation Agreements: Legal, Economic& Policy Aspects (Second Edition), (2009) p32.
[3] Thomas Waelde, Abba Kolo., supra note p2.
[4] Stefan Kroll, The renegotiation and adaptation of investment contracts, Arbitrating Foreign Investment Disputes-procedural and substantive Legal Aspects Norbert Horn (ed.), (2004), p437.
[5] Stefan Kroll, supra note. p439.
[6] Nagla, Nassar., Sanctity of Contracts Revisited,(1995)p 175.
[7] Thomas, Walde, Abba Kolo., supra note p 47.
[8] Stefan Kroll., Supra note p 440
[9] Ibid.
[10] See the decision of the English House of Lords in Walford v. Miles, 2 A C. 128, (1992), p138.
[11] Stefan, Kroll., Supra note p 448.
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