RENEGOTIATION CLAUSE---In Pursuit of Economic Equilibrium

By Liang Peng

As discussed in my previous articles (Renegotiation Clauses in International Investment Contracts & The Disputes over the Renegotiation Clause) renegotiation does not go smoothly without dispute, that is why international arbitration plays an important role for the effectiveness of renegotiation clauses. Studies show in most investor-State investment contracts, the parties will not go to the arbitration if they can reach an agreement themselves through renegotiation.[1] When the parties come to arbitration for renegotiation dispute, they either want the tribunal to restore the balance of economic interests under drastically changed circumstances, or terminate the contract and get compensation for damages. Although the procedure of renegotiation is important, the substantive aspects or the result of disputes arising out of renegotiation are also critical, which will affect the effectiveness of renegotiation clauses. If the work of the arbitral tribunal is only to give instruction on the procedure of renegotiation and evade dealing with interests of the parties, the renegotiation clauses would have no meaning to restoration of economic equilibrium. Therefore, how the arbitral tribunal should intervene in case of a failure to reach an agreement needs to be observed in depth. 

Adaptation of Ongoing Contracts 

In many cases, there is a request for the tribunal to adapt an on-going contract in renegotiation disputes. However, as pointed in section 2.3, it’s difficult for the tribunal to adapt an ongoing contract. The reason for this originated from the commonly recognized legal principle of the sanctity of contract in all legal systems. The principle requires that the terms of the contract must be implemented to the letter, no matter how onerous or burdensome they may prove to be. The individual is the best judge of his/her own interest and if he/she strikes a bad deal then he/she should blame him/herself and bear the risk. [2]It is neither the duty of the court nor that of the State to enquire into the fairness or otherwise of the contract; their role is to enforce what the parties have agreed to do.[3]

In practice, a common view is that only the tribunal is empowered clearly and explicitly to adapt the contract, can it do so. [4]But, how can a case meet such requirements? This is by and large a case by case issue. Furthermore, in international arbitration, the arbitrator usually takes into account the principles of law. Different legal systems tend to hold different views towards renegotiation. Common-law system, in particular English law with its emphasis on sanctity of contract tends to give less scope to a claim by one party as to renegotiability of a long-term contract; Civil-law system, however, is more open to renegotiability of a long-term contract. 

Recently, the trend has been observed that the rule of sanctity of contracts is no longer absolute under the majority of national contract laws, as well as international laws. In exceptional circumstances changes in the contractual environment can either lead to renegotiation or adaptation of the contract, excuse the non performance of the contractual duties or at least bar a party from invoking its contractual rights, even without the explicit renegotiation clauses [5]; even in common-law countries, like the UK, under the extremely arbitration friendly English arbitration Act 1996, arbitrators today are authorized to undertake such legal creativity to quite a broad extent thanks to the broad term of “dispute”.[6] The Switzerland went even further. The Swiss Supreme Court has held in a decision of December 2001 that under Swiss law arbitration tribunals can fill gaps arising out of a failure to agree under a renegotiation clause even without an explicit empowerment. Unless the arbitration clause limits these powers the tribunal can fill contractual gaps by looking for the hypothetical will of the parties. There is to be side in favour of wide interpretation of the arbitration clauses in contracts with an adaptation or renegotiation clause. [7]

Compensation 

In case the parties elect to terminate the contract due to a failure to reach agreement, how should the compensation be decided, and what standards should apply? A review of major cases about renegotiation shows that no uniform standard can be followed. Even if similar facts exist in two cases, the results are quite different. In The Karaha Bodas arbitration, the Indonesian state company PLN breached the contract during the financial crisis, the applicant KBC claimed the damages including future profits. The tribunal based its calculation of the profits on the terms of the contract as originally agreed upon. In another similar case, the Himpurna arbitration, the tribunal refused to base its calculation of profits on the original terms of contract. [8]

Although there are different approaches in practice, the principle of economic equilibrium should always apply. Such principle has already been recognized in Model Petroleum Production Agreement (PSA) in some countries. In Azerbaijan’s Shah Deniz contract, it states” …..any changes in tax legislation, regulations or administrative practice, or jurisdictional changes pertaining to the Contract Area, the terms of this Agreement shall be adjusted to re-establish the economic equilibrium of the Parties, and if the rights or interests of Contractor have been adversely affected, then SOCAR (the NOC) shall indemnify Contractor (and its assignees) for any disbenefit, deterioration in economic circumstances, loss or damages that ensue therefrom.” The similar words can also be found in the Model PSA of the Kuridistan Regional Government (KRG) and PSC of the Vietnam. [9] It’s reasonable that the compensation should be decided in arbitration based on the principle of economic equilibrium, in other words, it should balance the benefits of the parties as they agreed when contracts signed. 

Homerun 

More than twenty years ago, Professor Norbert Horn stated that renegotiation is “a common effort by the parties to adapt a contract to a new situation through a material change of its terms”, Renegotiation itself ‘points more clearly to the procedure-the common effort of the parties-than to the result, the adaptation or restructuring of the contract. “[10]Although it make sense in distinguishing the renegotiation and the adaptation, it’s advisable that in international investment contracts, the renegotiation clause should integrate both of them, this will make the renegotiation clause effective and enforceable to restore economic equilibrium under most legal systems in case of the possible international arbitration in future. 

As we can observe based on the above discussion, the renegotiation clause is still important to international investment contracts today. It seems that in developing countries where foreign investment is needed, the government will include the renegotiation clause in order to insure the investors prospected economic return without worrying about the drastic change of situations. In contrast, when the IOCs dominated the oil industry during early 20 century, we can not see in early concession agreements provisions providing for renegotiation of the terms and conditions in the event of a change of circumstances, [11]this is because IOCs controlled almost every aspect from exploration to exploitation and production instead of the HCs or NOCs. This means that whether the renegotiation clause or what kind of wording of the renegotiation clause will be written in the contract is much dependent on the bargaining power of the contracting parties. It seems that the culture elements have little effect on content of investment contracts.[12]

Despite of different of views towards the empowerment of arbitrators to renegotiate and adapt an ongoing contract, it’s advisable that the parties have made their intentions clear that they wish to transfer to the tribunal this “creative competence” which goes beyond normal dispute adjudication. Yet, the arbitration is not a perfect thing, as well as to renegotiation. In natural resources investment, factors affecting the contracts are complex, all political, economic, and social considerations may be taken into account in renegotiation. Therefore, we should always keep in mind the words of Horn;...no court or arbitrator in the world, at least in international business transactions, can render an award that could serve as the legal basis for a complex future cooperation against the will of one of the parties. There are definite limits to the powers of arbitrators to adapt a contract. “[13]

NUTSHELL:

This is the 3rd installment by Liang on various concepts associated with the Renegotiation clause in International Arbitration. In his first article, Liang focused on the Structure of the Renegotiation clause, discussing the Trigger event, content of the obligation to negotiate, and consequences of a failure to negotiate. In his second article, Liang elaborated on these concepts and relevant cases in greater detail with a view to unearthing critical focal points such as 'Good faith', 'Acceptable compromise' and so on. Now, Liang has discussed some salient issues that deal with Economic Equilibrium. In this analysis he has shed more light on the need to ensure balance in every contract- Although in order to achieve balance the sanctity of the contract must always be maintained. For more information on this article and to view Liang's professional profile click here -->

[1] See Stefan, Kroll, in sixe cases cited, the claims are either the adaptation of an ongoing contract, or damage compensation. 

[2] Thomas Walden, Abba Kolo., supra note p8. 

[3] P.S. Atiyah, An Introduction to the Law of Contract (5th ed), (1995), p7-15, 27-34,265-83. 

[4] Stefan Kroll, supra note p 452. 

[5] Stefan Kroll, supra note p458. 

[6] K.P.Berger., Renegotiation and Adaptation of International Investment Contracts The Role of Contract drafters and Arbitrators, Oil, Gas and Energy Law Intelligence (Volume 2 issue-4, 2004) p29. 

[7] Stefan Kroll, supra note p457. 

[8] Stefan Kroll, supra note p428-430. 

[9] Peter D Cameron., supra note p 77, 81. 

[10] Horn. N., The Concept of Adaptation and Renegotiation in the Law of Transnational Commercial Contracts, in Adaptation and Renegotiation of Contracts in International Trade and Finance, (Horn, N ed1985), p9. 

[11] Duval Claude, Honore Le Leuch, Andre Pertuzio, Jacqueline Lang Weaver, supra note p 62. 

[12] Thomas Walden, Abba Kolo claimed that there exists the high trust society and low trust society in the world, people from different cultures are difficult and expensive to renegotiate. See supra note p 52. 

[13] K.P.Berger, supra note p33-34.