INT ERNAT IONAL ARBI TRAT ION
DI SPUT ES IN THE OIL & GA S INDUSTRY ARE ON THE RI SE .
THI S I S SUE
MESS AGE FROM THE EDI TOR
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IN CONVERS AT ION WI TH MAARTEN SCHOLT EN General Counsel, Total S.A. DI ANE HUGHES Managing Director, AlixPartners
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RECENT C A SE L AW “ DRILL OR DROP ” AND C ARRY PROV ISIONS IN EXPLORATION AGREEMENT S RECENT C A SES ON THE INT ERPRETATION OF CONTRACT S
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INSOLVENCY L AW V ARBITRATION
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SPECI AL REPORT – POLITI CAL UNREST AND SANCTIONS THINGS FALL APART. . .
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INVES TING IN IRAN
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UPS TRE AM OIL & GA S DISPUT ES IN SUB -S AHARAN AFRI C A
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MARKE T COMMENTARY GLOBAL OIL PRI CE VOL ATILIT Y REPORT: RISKS AND OPPORTUNITIES IN 2016
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CLYDE & CO ’ S TOP TEN LEGAL TIP S : DISPUT E RESOLUTION
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GA S PRI CE REOPENERS – IS THERE A BE T T ER WAY?
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NEWS IN BRIEF PEOPLE MOVES MARKE T ACTI V IT Y NOTABLE C A SES
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FORTHCOMING E VENT S
INTERNATIONAL ARBITRATION 1/3LY
MESSAGE FROM THE EDITOR 01
ME S S AGE FROM THE ED I T OR It gives me great pleasure to present the seventh issue of the International Arbitration 1/3LY. In this issue, we take a look at an industry which has seen some of the biggest challenges in the global market over the last two years: oil & gas. Following a prolonged period of oil price volatility, companies in the upstream, midstream and downstream sectors have had to adapt their businesses to the changing landscape, resulting in job losses and cuts to projects. As we emerge from this downturn, we assess how disputes have affected the industry and provide practical tips for in-house lawyers to assist them in dealing with such issues.
Has the low oil price had an impact on the day-to-day issues faced by in-house counsel? Has there been an increase in the number of disputes in the oil &gas industry?We put these questions to General Counsel of Total S.A., Maarten Scholten and find out how life has changed inside Big Oil. We also take a look at themarket through the lens of a forensic accountant and discuss insolvency, fraud and international disputes with Diane Hughes, Managing Director at AlixPartners. Elsewhere in this publication, partner Richard Power discusses alternative dispute resolutionmechanisms in price reopener provisions with a detailed analysis of expert determination andMed-Arb. We also summarise recent case lawand assess the implications for the oil &gas industry: Richard Devine outlines what you need to knowabout drop or drill and carry provisions; Stewart Perry discusses the current position on the primacy of insolvency law over agreements to arbitrate; and I take a closer look at contractual interpretation.
Finally, in a special report, we turn our attention to doing business against the backdrop of political intervention and sanctions. JohnWhittaker outlines practical considerations for investing in Iran, with a discussion on the governing lawand forum for dispute resolutionwith Iranian counterparties; and Maurice Kenton looks at upstreamoil &gas disputes in Sub-Saharan Africa. On behalf of Clyde&Co, I would like to expressmy gratitude toMaarten Scholten and Diane Hughes for sharing their expert opinions and providing us and our readers with a unique insight into the oil &gasmarket. I also wish to thankmy colleagues from the firm’s global arbitration group and oil &gas group for their interviews and articles.
DAVID LECKIE, PARTNER, CLYDE & CO
DAV ID LECK IE SPE AKS WI TH MAART EN SCHOLTEN ON RI SK-TAK ING, MA INTA INING REL AT IONSHIP S AND HOW L IFE HA S CHANGED IN BIG OIL
MA A R T EN S CHOLT EN
D AV I D L ECK I E
INTERNATIONAL ARBITRATION 1/3LY
IN CONVERSATION WITH MAARTEN SCHOLTEN 03
IN CONVERS AT ION WI TH MAART EN SCHOLT EN GENERAL COUNSEL , TOTAL S . A . Maarten Scholten, General Counsel at Total S.A. in conversation with David Leckie, Partner at Clyde & Co.
DAV ID Absolutely – I verymuch agree. Lawyers can often find themselves pigeon-holed early on in their career and unwilling to take the risk of amove, so this is very refreshing advice. I would like to ask you about your borderless career at Schlumberger. Having progressed from legal to finance and then to operations, your career is certainly unique. Fromyour early days as Legal Counsel at Schlumberger, you rose rapidly through the ranks of the legal department to become Global Director of Legal Services. You thenmoved away from the legal department to become Head of Finance before becoming President of Schlumberger Oilfield Services ECA (Europe, Africa and CIS), and then Director of Mergers &Acquisitions/Business Development. What would you saywere the highlights of this remarkable career? MAART EN One thing I’mquite proud of is having been instrumental in adapting the legal function to changing business imperatives in Schlumberger and, to an extent, in Total. It was really about making sure that, as the business grew globally and becamemore complex, with newproduct lines and activities, we were always thinking about howwe could best serve our internal clients, and ensuring that we kept the standards up, as wemoved towards being amore global legal function. For a lawyer, the opportunity to have a borderless career is extremely important. I explored this concept duringmy time at Schlumberger, where I ventured outside the boundaries of the law. It was a good experience, which complementedmy skill set as a lawyer. I think it can be very useful as a lawyer to be able to say that you’ve done some work in a finance department or as an operational manager. This shows that you have an enriched understanding of the business. So, for me the highlights of my career have beenmaking sure that, at certain times, I took steps into the unknown, which ultimately helped to strengthenmy core competencies.
T HE SECRE T T O SUC CE S S? A BORDERL E S S C A REER
DAV ID Maarten, you have had a remarkable, borderless career which began as a law student at the University of Amsterdam, led you to aMaster of Science in Politics from the Sorbonne in Paris and then to New York, with a Dutch law firm. Howdid you first become involvedwith the oil &gas industry? MAART EN It was a total coincidence! When I was a young lawyer working in New York, I was part of a very international teamand I met and socialisedwith lots of other young lawyers. A couple of my good friends had already been recruited by Schlumberger, whichwas headquartered in New York. They were extremely positive about life as an in-house Counsel and arranged for me tomeet the General Counsel of Schlumberger, who at that time was David Browning. Themeeting went very well but I didn’t think I was ready tomove in-house. At the time, I was focused on going back to Holland to spend a fewmore years workingmyway up the ranks in the law firm. However, my friends were quite persistent and kept on callingme until I finally said, “Okay, I’ve had enough of private practice, let’s go!” So, there was, in fact, no big plan to go in-house or to become an oil &gas lawyer. I just listened to friends and kept mymind open to new opportunities. The philosophy of my career has always been to take some risks and trust my instincts – sometimes it works and sometimes it doesn’t. Risk-taking, in a calculatedmanner, is something that can really launch a career.
IN THE UNI T ED STAT ES , THERE HAVE RECENT LY BEEN A S IGNIF I C ANT NUMBER OF BANKRUP TCIES AMONGST THE SMALLER INDEPENDENT PL AYERS , WHI CH I S A RECENT PHENOMENON IN OUR BUS INESS AND DEF INI T ELY A RESULT OF THE ST EEP DROP IN THE OIL & GA S PRI CE .
INTERNATIONAL ARBITRATION 1/3LY
IN CONVERSATION WITH MAARTEN SCHOLTEN 05
DAV ID Is this something that youwould encourage in- house counsel to do generally? MAART EN Well, yes. What we can offer in-house lawyers in large andmedium-sized organisations, is a good variety of work andmobility. Thismay not be appropriate or desirable for all in-house lawyers, but manywould benefit from taking a step outside of their roles to observe the legal function from a completely different perspective. Having said that, I also want to underline the importance of specialists and expertise. There are lawyers who have the skills, capability and intelligence to be very good in certain areas of expertise. We need them. On the other hand, there are others who havemore of a global commercial viewandwho aremore generalist. I think the trick is to have a good balance within the organisation and to offer interesting career opportunities which appeal to each of these different types of talent pools. DAV ID In January 2014, you became General Counsel of Total. Is the borderless career something you’ve tried to promote within Total, or was this already in place? MAART EN I think, generally, it was in place, as it is in many large corporate environments – that is what makes going in-house so attractive. Mobility is something that we are promotingmore andmore in today’s environment. Where I feel that we need to bemore creative is inmaking sure that lawyers who have in-depth expertise and knowledge in certain specialist areas, which are essential for a global company like ours, have a stimulating and rewarding career. This notion is not unique to the legal function, nor to the oil industry –we also see it in the technical community and in other industries. Sometimes the reward, or the attention, is givenmore tomanagers and generalists, as opposed to those who are specialists with deep expertise. I think there should be a better balance.
DAV ID In the legal function, howdoes the balance you are referring to tie inwith the use of outside counsel? MAART EN In Total, our objective is to do asmuch legal work as possible in-house andwe are proud of that. However, like a large number of in-house legal departments, we turn to people like you for expertise when needed. So, finding the right balance between our own generalists and specialists and outside counsel is critical and is something we keep under careful review.
DAV ID Do you think the contractual adjustments that you mentioned also spill into the liability and indemnity provisions between operators and contractors? Have you seen a movement towards the reallocation of risk and liability? MAART EN Some of the basic tenets of the waywe work together with the service industry should be given a fresh look. What we need to do is develop amore efficient way of working together, for example to review contracts and see how to better allocate risks. It seems tome that in certain cases we take similar risks on each side with each party taking out insurance to cover those risks, evenwhen they are overlapping. This is a waste of money. I do think, however, that major accidents have had a bigger impact on some of these risk allocation issues than the oil price cycle. TheMacondo blowout is perhaps themost obvious example of this. DAV ID I fully agree. To the extent there have been changes, or attempted changes, to the risk allocationwithin the sector that probably has beenmore driven byMacondo than the low oil price. DAV ID Have you seen an increase in the amount of disputes, as a result of the low oil price? MAART EN No, not really, for us, it has been quite flat. Yes, we have a huge number of suppliers and contractors, but themajor projects are done with a relatively limited amount of external players, and the external partners that we do work with, we know verywell and they are verywell known in the industry. If there is an increase in litigation it is probably related to bankruptcies but this generally involves the smaller players in the industry. There is a significant interdependency between a limited number of large players; so as a result, this is not the most litigious kind of environment, compared to perhaps other sectors of the economy. MA IN TA INING REL AT I ONSHI P S A ND MI T I G AT ING D I SP U T E S
OP ER AT ING IN A L OW O I L PR I CE EN V I RONMEN T
DAV ID Has the low oil price had a big impact on the type of day-to-day issues faced by in-house counsel generally? MAART EN There has been some impact but this is certainly not commensurate with the tremendous drop in oil prices. It takes time before big shifts in themarket cascade down to the legal departments of the large energy companies. In the United States, there have recently been a significant number of bankruptcies amongst the smaller independent players, which is a recent phenomenon in our business and definitely a result of the steep drop in the oil &gas price. More generally, I would say that the legal department has changed its focus. We are now lookingmore at contracts and pushing certain contractual terms which perhaps in the past were not given the same level of attention as they are today. Every penny counts. Lawyers looking after procurement and contracts now feel a lot more pressure tomake sure that we negotiate the best possible commercial terms and get the cost reductions that we need in order to be able to survive in a low oil price environment. I have been in this business for 30 years andwe’ve been through a number of these cycles. Due to the fact that we enjoyed high oil prices for a number of years, a lot of people forgot that this is a very cyclical business.
INTERNATIONAL ARBITRATION 1/3LY
DAV ID Yes, exactly, because the relationships are very solid and have been in place for years – you know that you have tomaintain relationships with these organisationsmoving forward, particularly once activity picks up. MAART EN Yes, andmost of themajor disputes are settled by a process that is close tomediation. There is a big drive for senior management to talk to their counterparts, and for all counsel involved in the issue to engage in an amicable and constructive way, as they know that on other fields, other projects, other assets, they are also working together. So overall, I would say that the number of disputes has increased at certain levels in the industry, but it is certainly not growing exponentially. DAV ID That certainly is consistent with our experience – a lot of these disputes are resolved by negotiation at a very high level nowadays, rather than going to litigation or arbitration. If you do end up in a dispute, do you have a preference for arbitration or litigation? MAART EN First of all, I amverymuch in favour of mediation. I really believe there is still a lot to be done in our sector to actively push contractual parties to engage in mediation in a professional manner. That being said, when it comes to disputes that can’t be resolved bymediation there are horses for courses and it all depends onwhere the dispute is andwho you are dealing with. There are definitely certain types of disputes and certain countries where arbitration is the best, and possibly the only, way forward. However, arbitration can be costly and slower than the court system.
At the same time, I have a lot of confidence in the court systems of a number of jurisdictions and, in certain jurisdictions, litigation through the courts would bemy preference.
The second one would be that law firms should lead the way in newbusinessmodels and in the use of IT, so that we don’t get stuck using obsolete, old-fashioned practices. The law firm is the place where innovative ideas about how to assist clients with legal matters have to be developed, and they then have to be very quickly presented to clients so that they can get traction. The businessmodel needs to be adapted and I look at my panel law firms to lead the way in finding out what can be done better andmore efficiently, adopting flexible pricing using technology and artificial intelligence, as opposed to clinging on to the way it was done thirty years ago. DAV ID Do you think the hourly rate has had its day? MAART EN Probably. Althoughwe are not there yet. But I wouldn’t be surprised if in a number of years the hourly rate will be used less frequently. If you look at companies in the finance sector, for example, much of the work is done on a fixed fee basis. So I think that withwork that can be standardised, andwhere performance indicators can be identified, we will definitely see a shift to different paying systems. DAV ID Yes, I agree. I think as in-house counsel continue to review their legal spend and improve efficiency, we will see a greater movement towards innovative fee structures. Maarten, many thanks for your time and for your invaluable insights.
A GENER A L C OUNSEL’ S A D V I CE T O PR I VAT E PR A C T I CE L AW Y ER S
DAV ID One last question please, which I’msure youmust get asked a lot: if you could give outside counsel one bit of advice as to how to provide a better service, what would that be? MAART EN One of my key responsibilities is tomake sure that we deliver legal services to the company in themost efficient way. So one of the things that we have done at Total is to limit the amount of law firms on our panel so as tomake sure that we create an environment where we can spend time working together, getting to know each other and exchanging knowledge. So, I think the first piece of advice for law firms would be to invest time and resources into nurturing that relationshipwith in-house counsel. The result is that when a case comes up and a file is opened, there is no need to spend time getting to knowyour client, so there is a lot of time and efficiency gained. In a similar vein, working with partners and teams at law firms that have a high degree of stability, as opposed to always introducing a new face or a new team, is an important matter because this greatly improves efficiency.
SO OVERALL , I WOULD S AY THAT THE NUMBER OF DI SPUT ES HA S INCRE A SED AT CERTA IN LE VELS IN THE INDUS TRY, BUT I T I S CERTA INLY NOT GROWING EXPONENT I ALLY.
IN CONVERSATION WITH MAARTEN SCHOLTEN 07
W I T H T H A NK S T O T HE C ON T R I BU T OR S OF T HI S E XCH A NGE . . .
MAARTEN SCHOLTEN, GENERAL COUNSEL, TOTAL S.A .
DAVID LECKIE, CLYDE & CO
Maarten R. Scholten has been Senior Vice President and General Counsel of Total S.A. since January 1, 2014. He has almost 30 years of extensive legal and financial experience from the oil service industry. He was formerly an executive for 20 years at Schlumberger, where he served as Director of Legal Service, Head of Finance, President Schlumberger Oilfield Services ECA (Europe, Africa and CIS), and Director of Mergers &Acquisitions/ Business Development. He has been a Director at the Association of Corporate Counsel since October 2015. Mr. Scholten holds aMaster of Science in Politics from the University of Paris (Sorbonne) and a JD Commercial Law from University of Amsterdam.
David is a partner in Clyde&Co’s Global Arbitration Group and Oil &Gas Group. He is a specialist in international commercial arbitration, litigation and regulatory law. He has represented clients in the UK courts at all levels, inmediations and in international arbitrations, including ICC and LCIA. David also has extensive experience of regulatory law, including fraud, bribery and corruption, health, safety, and environmental law. He was called to the Bar in 1994 and practised in the Chambers of Walter Aylen QC at Lincoln’s Inn. He was formerly Legal Counsel for Schlumberger and the Europe/Africa Director of the Association of International PetroleumNegotiators.
INTERNATIONAL ARBITRATION 1/3LY
GLOBAL OIL PRI CE VOL AT IL I T Y REPORT: RI SKS AND OPPORTUNI T IES IN 2016
In April 2016, the results of Clyde & Co’s independent global survey of the oil & gas industry were published in the Global Oil Price Volatility Report. The report assesses the current landscape of the oil & gas sector, following prolonged downwards pressure on prices, and highlights global trends, challenges and concerns of senior oil & gas executives. Drawing on the issues reported by respondents, partners from Clyde & Co’s Oil & Gas Group outlined proactive legal tips for businesses and identified the positive business opportunities within the current market conditions. The following is a summary of the salient findings published in the report and top tips for dealing with disputes in the sector.
P R I C E V S P R ODU C T I ON 92% have seen themajority, or all, of their business affected by the collapse in oil prices. Despite this, half (49%) expect global oil production to remain steady, with just over a quarter (28%) expecting it to increase
C ONF I DENC E V S C A U T I ON 81% describe their outlook as concerned but 19% are optimistic about the future; of this, 50% of optimistic respondents were fromNOCs
I NF L UENC E OF OP E C R EM A I N S A S I GN I F I C A N T F OR C E I N T HE M A RK E T OPEC policy and the slowing of the Chinese economy are themost significant geopolitical factors affecting businesses (according to 74% and 50% of respondents), followed by the impact of sanctions in locations such as Iran (41%)
KE Y F INDINGS
C URR EN T A ND F U T UR E P R O J E C T S ON T HE L I NE – Reduced profitability/viability of E&P activities, together with lack of appetite for investment in newprojects are the twin leading trends expected to affect oil &gas businesses in the coming year, by somemargin (with 64% and 59% of respondents flagging these up as critical) – However, themyriad of factors that respondents also said are coming into play highlights the scale of the challenges faced by the industry – from the cost of transportation and storage to increasing regulation and compliance requirements
R E S P OND I NG T O T HE NE W R E A L I T I E S – 78% say they are reacting cautiously or reactively to market conditions whilst 22% are taking an aggressive or opportunistic approach – Restructuring entire businesses or asset portfolios is the top priority –32% identified this as their number one strategy going forward – Almost half (41%) of IOCs outlined restructuring as a key priority in light of current market conditions, in comparison to 25% of those fromNOCs who listed the development of their downstreamcapabilities as their main focus
MARKET COMMENTARY 09
IMPACT ON BUSINESS If the squeeze on profitability continues, the widely expected increase in claims and disputes seems inevitable. As one of our survey respondents put it, keeping cash flowpositive, deferring large investments andminimising operating costs is essential. Changes to operational arrangements as a result of cost-cutting, the shelving of planned projects and lack of investment in existing operations, could all have amajor impact on relationships across the supply chain. According to our survey, the cancellation or breaking of agreements is expected to be the biggest cause of disputes for 86% of respondents, followed by companies or suppliers becoming insolvent and unable to fulfil their obligations (81%). Two-thirds (67%) think payment issues will be amajor trigger for claims and a third (31%) see failure to performobligations to the required standard or timeframe as a critical pressure point.
BUSINESS RESPONSE Current attitudes to litigation/arbitration in the industry have changed significantly over the past 12 to 18months. As a result of the financial pressures faced by the industry, companies are far more bullish than they used to be. There is, as a result, significantlymore contentious correspondence between parties, some of which ultimately leads to the commencement of proceedings. Some of themost common flash points for disputes include non-payment of invoices, termination of contracts (purportedly for cause but in fact for convenience), declarations of forcemajeure and JV/PSA disputes. Clearly, any decision to commence proceedingsmust be carefully risk assessed bymanagement and legal. The direct costs of litigation/arbitration are significant, not tomention the hidden costs of extensivemanagement time, reputational issues etc. The stakes are high, particularly if the dispute is under English lawwhere the loser will almost always be ordered to paymost of the winner’s legal costs. At the same time, companies are often facedwith the stark choice of either having to write the amount in issue off/pay the sumdemanded or litigate/arbitrate. Inmany situations the onlyway forward is to commence proceedings and then seek to resolve the dispute byway of alternative dispute resolution, such asmediation. A key issue to consider before commencing any proceedings is whether any judgment/award can be enforced. In international disputes this is a very complex issue which needs to be addressed at the outset, to avoid pouring goodmoney after bad.
T HE R E I S E X P E C T ED T O BE A N I NC R E A S E I N C L A I MS A ND D I S P U T E S O V E R T HE C OUR S E OF 2016 . DO Y OU BE L I E V E T H I S A C T I V I T Y W I L L P R EDOM I N A N T LY BE T HE R E S ULT OF :*
81% Companiesorsuppliersbecoming insolvent andunabletoperformobligations 86% Cancelling or breaking of agreements 67% Payment issues 1% Changes in regulations and non-conformance 3% Employment claims 4% Usual business operations 31% Failure to performobligations to the required standard or timeframe
HOW IS THE OIL & GA S INDUSTRY MANAGING ITS CONTRACTORS AND SUPPLIERS?
*Respondents were asked to select amaximumof three answers
WHE R E DO Y OU E X P E C T T HE M A J OR I T Y OF D I S P U T E S T O A R I S E ?
83% UP S T RE AM (exploration and production) 13% MI DS T RE AM (transportation, storage, wholesale marketing)
32% Renegotiating contracts
42% Closelymonitoring activities of supply chain and aware of stress points
21% Pre-emptively reviewing contractual obligations and performance
5% No action as all necessarywork has been done
5% DOWNS T RE AM (refining, processing, marketing and distribution)
*The survey was published in February 2016. Survey respondents included a cross-section of senior professionals working within the global oil & gas industry.
INTERNATIONAL ARBITRATION 1/3LY
MARKET COMMENTARY 11
CLYDE & CO ’ S TOP T EN LEGAL T IP S : DI SPUT E RESOLUT ION
The financial pressures caused by the low oil price has led to a significant increase in the number of disputes in the industry, at all levels in the contractual chain. Set out below are some key points to keep in mind when considering litigation/arbitration.
01 PRE CONTRACT – carry out extensive credit checks and, if possible, obtain security 02 BE V IGIL ANT – keep a constant eye on unpaid 03 KEEP C AREFUL RECORDS – document all phone calls and meetings and preserve all emails and documents 04 REVIEW CONTRACT TERMINATION PROVISIONS – in particular termination for cause – and follow the contractual notification process to the letter 05 DON ’ T DEL AY – consider the choice of law and dispute resolution clauses and escalate the dispute resolution process sooner rather than later 06 ADR – make sure you closely follow any contractual alternative dispute resolution procedures before commencing litigation/arbitration invoices and the changing financial status of the debtor
07 LOOK C AREFULLY AT ENFOR CEMENT BEFORE SPENDING A LOT OF MONE Y ON L I T IGAT ION / 08 IF THE COUNTERPART Y I S IN SERIOUS F INANCI AL DIFF I CULT Y, L I T IGAT ION/ARBI TRAT ION SHOULD BE COMMENCED A S QUI CKLY A S POSS IBLE – it may be possible to obtain a judgment in default and enforce that (eg by a third party debt order or a charge over property or shares). Once enforcement is complete this may allow you to keep the recovery, as a secured creditor. However, if you do not complete enforcement before an insolvency process commences, you are usually part of the general body of unsecured creditors (and may make only a minimal recovery) ARBI TRAT ION – there is nothing worse than a Pyrrhic victory 09 CONS IDER US ING EXPEDI TED PROCEDURES WI THIN THE RELE VANT ARBI TRAT ION RULES OR RULES OF COURT – consider interim remedies, such as freezing of assets and security for costs 10 MANAGE THE LITIGATION/ARBITRATION CAREFULLY – through cost control and consideration of innovative litigation funding, such as third party funding or insurance backed products. Don’t throw good money after bad
INTERNATIONAL ARBITRATION 1/3LY
GA S PRI CE REOPENERS – I S THERE A BE T T ER WAY?
THE PROBLEMS WITH ARBITRATION Reality seldom reflects the theory. Many parties’ experience of gas price reviewarbitrations has been a lengthy and frustrating process which gets bogged down in technical legal arguments. Among the problems are the following: • In practice, the parties seldomappoint anyone other than a lawyer as an arbitrator, and even then, one of a small group of experts in the field. This could be because the arbitration clause requires it (demonstrating a disconnect between the lawyer who drafted the clause and the lawyer who will conduct the arbitration); or because the parties are cautious, wanting the security of an experienced lawyer to administer what is a legal process; or because of simple laziness of thought, a “this is the waywe do things in arbitrations” approach. Sometimes it is because the parties want to run technical legal arguments rather than engage on the economicmerits. • Choosing one of the small band of “expert” lawyer arbitrators creates its own set of problems: o First, a tribunal of “expert” arbitrators, who are involved in a large number of gas price arbitrations, will have less availabilitywhich can cause delays. o Secondly, in an industrywhere there are a limited number of participants who all trade with one another, the chance of there being a conflict of interest of the type appearing on the IBA Guidelines’ Red or Orange Lists is increased. o Finally, a tribunal of lawyers will require expert economic evidence, whichwill often be voluminous and expensive. • The parties’ legal representatives, and the arbitrators themselves, can often approach a gas price reviewarbitrationmechanically i.e. as if it were an international commercial arbitration relating to a breach of contract/tort/restitution etc. claim. Arbitrations are often runwithout recognising there is no true “dispute” and neither party is “at fault” – this is amechanism to bring a deadlocked renegotiation process to a conclusion. That can result in the parties producing unnecessary evidence, and/or adopting a timetable which could be dramatically shortenedwith a bit of creative, focussed thought. • The fact that the price renegotiation issue will be referred to arbitration can encourage a party to stall, or not engage properlywith, the negotiation process. A partymay know that it is weak on commercial/economic arguments but has a reasonable technical legal argument (e.g. the price reviewnotice was not served on the correct address), or has spotted that the tribunal’s terms of reference are limited such that the award they can render will be less harmful than the result of a negotiated deal. It might simply be that one party can bear the cost of a lengthy arbitration better than the other party, so it can use this pressure to negotiate a better deal some time into the arbitral process. Instead of the arbitration being a speedy, cheap and expertly-determined conclusion to a consensual negotiation process, it can actually subvert that process and become a Pandora’s box of cost, delay, procedural applications, jurisdictional challenges and tactical manoeuvring. In the following we look at two alternativemethods of dispute resolution – expert determination andMed-Arb – and assess their suitability in resolving gas price reopener disputes.
BY RICHARD POWER, PARTNER, CLYDE & CO
Most long-term gas supply agreements contain a mechanism for determining the contract price for the supply of gas, usually by reference to external factors such as the oil price, or more recently, the price at a specific trading hub. Such agreements also normally contain price reviewmechanisms to deal with changes in circumstances over the contract term. When triggered, these provisions require the parties to attempt to renegotiate the contract price to reflect those different circumstances or, failing agreement within a specified period, to refer the request for a price review to arbitration. There are many reasons why arbitration became the default option for breaking the deadlock in price reopener negotiations. Arbitration offers numerous advantages over the obvious alternative, litigation: the ability to appoint ‘expert’ arbitrators; a speedier resolution; enforceability of arbitral awards in different jurisdictions, afforded by the New York Convention; and confidentiality which, in commercially sensitive matters such as pricing, is essential.
MARKET COMMENTARY 13
EXPERT DE TERMINAT ION – THE SOLUT ION?
PROBLEMS WI TH EXPERT DE T ERMINAT ION
THE DISPUTE RE SOLUTION MECHANISM IN A PRICE REOPENER PROVISION SHOULD REFLECT ITS PURPOSE – TO CONCLUDE THE PROCE S S OF T WO PAR TIE S NEGOTIATING IN GOOD FAITH TO AD JUST THE CONTRACT PRICE TO REFLECT CHANGED ECONOMIC RE ALITIE S. IT IS A TA SK WHICH REQUIRE S E XPER TISE IN THE GA S MARKE T IN GENERAL AND THE PAR TICUL AR MARKE T(S) RELE VANT TO THE CONTRACT IN PAR TICUL AR. INSTE AD OF E ACH PAR T Y PRODUCING E XPER T E VIDENCE TO SUPPOR T ITS C A SE , WHY NOT APPOINT AN E XPER T TO RE SOLVE THE DE ADLOCKED NEGOTIATIONS? Expert determination is recognised in English law, andmany other legal systems, as a contractually-bindingmethod of dispute resolution, inwhich a neutral, jointly-appointed expert issues a binding determination of the question before him. The process is commonly used for disputes relating to accounting and technical operational issues. Expert determination clauses usually specify the qualifications the expert should have; a process for his/her joint appointment, and default provisions should the parties not agree; and the procedure to be followed. The procedure is up to the parties - often it is a simplified version of thememorial-style procedure used in arbitrations, with each party submitting its written submissions (legal and technical) along with any supporting evidence, possiblywith a second round of submissions in reply. The expert will usually determine the issue within a specified period, oftenwithout a hearing. There are now even default rules which can be incorporated by reference (e.g. the ICC Expert Rules, launched in January 2015). In English law there are limited grounds to challenge an expert’s decision: fraud/ collusion; partiality; material departure from instructions; failure to state reasons; and, if the expert determination clause so provides, manifest error. Otherwise, the expert’s decisionwill be binding upon the parties because they contractually agree to be bound. So expert determination offers a private, confidential, flexible and speedymethod of concluding the price reopener process. Since the issue will be determined by an expert in gas purchasing, limited expert evidence will be required. Overly technical legal arguments will be dissuaded as they are unlikely to sway an expert asmuch as a tribunal composed of lawyers. Challenges to the composition of the tribunal, procedural hearings and even oral merits hearings can be kept to aminimum, speeding up the process and keeping costs down.
SO IS EXPERT DETERMINATION A PANACE A? POSSIBLY NOT, BEC AUSE IT SUFFERS FROM THE FOLLOWING DRAWBACKS: • The expert determination cannot be registered and enforced like an arbitral award. A refusal to abide by the decision is a breach of contract, so the determination is “enforced” by a breach of contract claim(in England, summary judgment will often be available). In a cross-border context, thismight invite satellite litigation, effectively re-opening thematter. Moreover, the jurisdiction where enforcement is sought might not recognise expert determination as a valid dispute resolutionmethod. • Where there is a dispute concerning the jurisdiction of an expert, there is no principle of kompetenz-kompetenz. This could result in a challenge in the national courts (although the prospect of this can beminimised by awell-drafted expert determination clause). • There are no supportive rules of procedure like the Arbitration Act 1996. So, for example, it is generally not possible for an expert to order a party to disclose documents or to issue awitness summons. • If there is an important legal principle which needs to be decided to dispose of the price reviewnotice justly, an expert will probably not be as well placed to deal with it as an arbitral tribunal. This can be addressed by allowing the expert to take his own legal advice, perhaps froma lawyer who ismutually acceptable to the parties; however, this could effectively become a “summary arbitration” in itself, undermining the parties’ confidence in the process.
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MED - ARB : A NEW HOPE? MED-ARB IS A FORM OF ARBITRATION IN WHICH THE ARBITRATOR STARTS OFF A S A MEDIATOR, (AN INDEPENDENT THIRD PART Y WHO AT TEMPTS TO BROKER A DE AL BET WEEN THE PARTIES) BUT IF MEDIATION FAILS, HE BECOMES AN ARBITRATOR AND IMPOSES A BINDING DECISION. MED-ARB IS QUITE COMMON IN CHINA , HOWE VER, AT PRESENT, IS NOT WIDELY USED IN THE UK OR THE US A . The advantages of Med-Arb for a gas price reopener are obvious: • Med-Arb recognises the unique nature of a price reopener process, and offers the opportunity to conclude deadlocked negotiations with amutually-acceptable negotiated solution. Instead of there being a sudden break between the contractually-imposed but time-limited price renegotiation process and the commencement of arbitration, there is a smooth progression fromnegotiation to mediation to arbitration. • The costs of the arbitration process, and its uncertain imposed award, incentivise the parties to agree a settlement, and they are assisted to do so by the skills of the mediator who is experienced in “getting the deal across the line”. • The fact that the same party acts asmediator and arbitrator avoids duplication of process, resulting in a saving of costs if there is no settlement and thematter proceeds to arbitration. • The parties are able to explain their position to themediator in amore informal and commercial context, allowing themediator/arbitrator to get a better idea of the full picture andmake his award accordingly.
MED - ARB : THE DRAWBACKS THERE IS A KE Y CONCEPTUAL PROBLEM WITH MED-ARB WHICH MIGHT MAKE PARTIES HESITATE BEFORE AGREEING TO IT. THE SUCCESS OF MEDIATION WILL OF TEN DEPEND UPON HOW OPEN THE PARTIES C AN BE WITH THE MEDIATOR. Themediator is bound by duties of confidentiality not tomention to the other party anything which is said to him in confidence, so a party can tell him facts whichmight be relevant to the settlement of the dispute – e.g. details of their financial position andwhy they need to achieve a certainminimumprice – safe in the knowledge that the other side will not become aware of those facts. This places amediator, who subsequently has to rule on the dispute as an arbitrator, in a difficult position: he cannot base his decision on factswhich have been communicated to him in the absence of the other party being given an opportunity to comment andmake submissions on them. That would be a breach of procedural fairness. So the parties have to trust themediator/arbitrator to dismiss fromhismind everything which he has been told in confidence in themediationwhen hemakes his award. If they do not do so – and it is somewhat naïve to expect amediator/arbitrator not to be influenced by some of the things he has heard - theymight not be openwith themediator in themediation, and by holding back information they endanger the effectiveness of themediation. One can get round this issue in a number of ways, all of which could perhaps more accurately be described as Arb-Med-Arb: • One could have a different party conduct themediation, as is common in litigation in England&Wales and as happens where parties adopt the Singapore International Mediation Centre - Singapore International Arbitration Centre protocol. However, this can add to the cost of resolving the reopener request, because the parties have to run two distinct processes, either in parallel or in tandem. • One could run the arbitration and have amediator sit in on themerits hearing, and then hold themediation before the award ismade. Themediationwould then be fast-tracked, as themediator will be fully up-to-speed on the case. If there is no settlement the award is handed down in the usual way, but if there is, it can be encompassed in the award instead of the arbitrator’s decision on the merits. However, thismeans incurring the costs of the arbitration followed by the (potentially reduced) costs of themediation. • One could have the same individual as arbitrator andmediator, but hold the mediation after themerits hearing and after the arbitrator/mediator has prepared his draft award. If settlement is not possible, he hands down his award there and then, uninfluenced bywhat he has heard in confidence. Again, however, thismeans incurring the costs of a full merits hearing and amediation.
MARKET COMMENTARY 15
BA SEBALL / PENDULUM AND HI - LO ARBI TRAT IONS
CONCLUS ION Adopting a straightforward one-size-fits-all approach to gas price reopener arbitrations does not serve the parties’ best interests. Themost radical solutions are to adopt expert determination or Med-Arb in place of traditional arbitration procedures, but both options pose practical problems. Baseball/Pendulumand Hi-Lo Arbitrations offer amethod of constraining the tribunal’s discretion and to preserve the parameters established by the renegotiation process. But perhaps themost simple way of serving the parties’ needs would be for practitioners and arbitrators alike to recognise the special nature of a gas price reopener and to be flexible enough to adopt procedures which reflect that. For example, restricting the volume of expert evidence; hot-tubbing rather than full-blown counsel cross-examination of experts; and papers-only hearings, or time-limited oral merits hearings, can all assist a speedy and less costly disposal of the case. Similarly, the parties can help themselves by appointing arbitrators with appropriate industry expertise and good availability. The solutions are, perhaps, closer than they seem.
Med-Arb is not the only type of “exotic” arbitration process which lends itself to gas price reopeners. One perceived problemwith gas price review arbitrations is that the tribunal might end up rendering an award which is actually much worse for one party than the position on offer when the preceding renegotiation process ended. Baseball/Pendulum and Hi-Lo Arbitrations address this problem: In baseball arbitration, each party submits a proposed award to the arbitrator. After themerits hearing, the arbitrator chooses one awardwithout modification. • “Day baseball arbitration” - the arbitrator is aware of the parties’ proposed awards and chooses the one he considers to be themost appropriate. • “Night baseball arbitration” , the parties’ proposed awards are kept confidential from the arbitrator; after he renders his award the party-proposed awardwhich ismathematically closest to the arbitrator’s award becomes binding. Either way, baseball arbitration gives the parties certainty of the parameters of their arbitration by limiting the arbitrator’s discretion, and preserves a degree of continuity of the renegotiation process by giving each party an opportunity to offer a “reasonable” proposal to the arbitrator, with the hope that it will be accepted. These types of arbitration are fairly common in the USA, particularly salary arbitration inMajor League Baseball (hence the name). Hi-Lo/High-Lowarbitration is where the parties privately agree to a range inwhich the arbitral awardmust fall, without informing the arbitrator – for example, these could be the parties’ final positions on price at the end of the renegotiation process. The arbitrator’s award is adjusted to the range agreed between the parties. If it is lower than theminimumprice in the range, it is automatically adjusted up to that minimum; conversely if the award sets the newprice higher than the upper limit, it is adjusted downwards. If the price awarded is within the agreed range, then it will be binding upon the parties. In this way, the parties can ensure that the final award does not depart from the parties’ last positions in the renegotiation process.
RECENT C A SE L AW
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SPECIAL REPORT 17
KEEP C ALM AND C ARRY ON : “ DRILL OR DROP ” AND C ARRY PROV I S IONS IN EXPLORAT ION AGREEMENT S
To survive in the most bearish oil market for decades, E&P companies must cut costs, minimise risks and maximise returns. Exploration activity suffers as a result, but low oil prices do not relieve E&P companies fromminimumwork obligations in production sharing contracts (PSCs). PSCs typically include “drill or drop” provisions that make the performance of defined exploration activities a condition of keeping the agreement alive. A common solution for E&P companies seeking to diversify their exploration risks is to sell or farmout some of their participating interests in a PSC in return for a promise from the buyer that it will fund all or part of minimumwork obligations (a carry). A recent English High Court judgment concerning an exploration block in amajor new oil province illustrates howdrill or drop and carry provisions can be affected by operational contingencies. Asmarket conditions tighten, oil explorers aremore likely to use Carry arrangements. Given the industry’s preference for international arbitration, the case of Adamantine Energy (Kenya) Limited v Bowleven (Kenya) Limited offers a rare insight into howEnglish Courts will interpret drill or drop and carry provisions and provides useful guidance to the industry. To avoid an unnecessary dispute, careful drafting is essential and parties should enter into such arrangements with a clear-eyed view of all eventualities.
BY RICHARD DE VINE, PARTNER, CLYDE & CO
TO SURV I VE IN THE MOS T BE ARI SH OIL MARKE T FOR DEC ADES , E&P COMPANIES MUS T CUT COS T S , MINIMI SE RI SKS AND MAX IMI SE RE TURNS .
INTERNATIONAL ARBITRATION 1/3LY
THE CONTRACTUAL ARRANGEMENTS On 30May 2012, Adamantine (as contractor) acquired an interest in the East Africa Rift System play by entering into a PSCwith the Government of Kenya. The PSC anticipated a six-year exploration phase divided into three periods. Each two-year period contained certainminimum spend (MS) andminimumwork obligations (MWO) for Adamantine. The Government was obliged to allow Adamantine tomove into the next exploration period if theMS andMWOwere completed. On 14 September 2012, Adamantine transferred a 50% participating interest in the PSC to Bowleven pursuant to a Sale and Purchase Agreement (SPA). In return, Bowlevenwas required to carry theMS for each exploration period. Bowleven subsequently farmed out a 30% participating interest in the PSC to First Oil. The SPA provided that no later than threemonths before the expiry of each exploration period (or any extension thereof) the parties would vote onwhether to continue with exploration or to relinquish the PSC. If both parties voted to drill, Adamantine would seek to activate the next exploration period in accordance with the PSC. If both parties voted to drop, theywould relinquish the PSC. However, if one party voted to drill and the other voted to drop (the relinquishing party), then the relinquishing partywould exit andwould be required to transfer its 50% participating interest to the other party for nil consideration. In accordance with industry standard practice, a Joint Operating Agreement (JOA) dated 12 October 2012 between Adamantine and Bowleven supplemented the SPA. THE DISPUTE Both Adamantine and Bowleven acknowledged that theywould not complete theMWO for the IEP (initial exploration period) by the deadline of 26May 2015. Work was already behind schedule when disaffected locals attacked awork camp in January 2015 and caused seismic work to stop. Adamantine had sought, but had not (yet) been granted an extension to the IEP by the Government. Nonetheless, Adamantine called for amanagement committeemeeting and a drill or drop vote on 25 February 2015 (i.e. threemonths before the expiry date of the IEP). Bowleven responded that the call for a vote was premature and invalid. Bowleven argued that since it was clear they would not complete theMWO by the IEP deadline, the right tomove into the 1AEP (first additional exploration period) did not exist. Regardless, Adamantine proceededwith the drill or drop vote and voted tomove into the 1AEP. During themanagement committeemeeting Bowleven voted “yes” to proceeding, conditional on receiving the extension to the IEP. Bowleven insisted at themeeting that a conditional vote was valid and should be recorded. Adamantine characterised Bowleven as having voted not tomove into the 1AEP (i.e. having voted to drop its participating interest). In a followup email, Bowleven said that, if required to vote, it voted no on the basis that the parties were unable tomove into the 1AEP. Bowleven also stated that, if the IEP expiry date was extended, its no vote should be considered invalid and there should be a further vote no later than threemonths before that extended expiry date. Adamantine subsequently instigated proceedings to establish that the vote was valid and that it was entitled to Bowleven’s participating interest in the PSC because Bowleven had voted to drop its interest.
THE DECISION The Court said that the commercial rationale for the voting timetable was to balance two competing needs: 1. each party’s need to have themaximumopportunity to assess the existing data before being required tomake the drill or drop decision; and 2. each party’s need to have sufficient time tomake the arrangements for the next exploration period should a party elect to continue with exploration (for example, securing necessary finance or farming out a participating interest). The parties had agreed that holding a drill or drop vote threemonths before the next exploration periodwas due to begin struck the right commercial balance between these needs. The Court held that the drill or drop vote called by Adamantine was not valid. The Court noted that if Adamantine’s call for a vote was valid, and Bowleven had voted yes, then if the Government extended the termof the IEP the parties would have been irrevocably committed tomoving into the 1AEP and there would not have been a vote threemonths prior to the expiry of the extended IEP. In effect, the parties would have taken their decisionwithout the benefit of the results of the data collected during the extension. In addition, this would have hinder the parties’ forward planning as the decision to continue explorationwould have been dependent on a variable outside their control, namely, the Government agreeing an extension under the PSC. This outcome was contrary to the commercial rationale for the agreed timetable for the drill or drop vote.
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