The Whole Wide World

The demand for energy isn’t slowing down. The same is true for the varied international litigation that has flourished within the sector.

Just as energy fuels the fast-growing global economy, the energy sector also propels the growth in disputes worldwide. These disputes involve a wide range of parties and issues, and are often driven by the clash of interests competing for the world’s natural resources and for the financial benefits derived from their development. A look at litigation trends across the world provides an interesting overview of differences and similarities among competing stakeholders in the natural resource arena.

AFRICAMany governments in this region are laden with debt, some of which is purchased at a discount and held by so-called “vulture” funds. These funds now are attempting to collect by garnishing the royalties and other obligations owed to the host governments by energy companies. The funds have won some of these cases in the United States, Great Britain and France. Meanwhile, host governments continue to demand already garnished payments under their existing contracts. Caught in a squeeze, international energy companies, in effect, may be asked to pay twice or risk allegations of default in their concessions. What may be considered a plain vanilla garnishment action where the garnishee is discharged from the debt after paying the garnishor is not ordinary at all when delicate concession relationships with host governments are involved. The social consequences to disadvantaged nations of these funds’ efforts to collect debts has attracted the attention of the U.S. and British governments, world funding organizations and other groups that are concerned that citizens of resource-rich developing nations will be deprived of funds that will not show up in the countries’ coffers.

After making major investments under long-term contracts, international oil companies are beginning to see a return on risked capital. The problem is that many of their host-government partners also see those returns and are now attempting to require a greater share of those profits through various surcharges aimed at pre-existing contracts. The result is a growing string of semi-formal and formal dispute resolution proceedings, from conciliation to arbitration to litigation in local courts, and further litigation related to the recognition and enforcement of awards.

Although disputes among international oil companies in joint ventures do not often end in litigation, matters related to various agreements linked in the energy value chain may wind up in the courtroom or arbitral tribunal, due to legal and technical problems, and perhaps even geopolitical ones. Boundary disputes may also crop up leading to dispute resolution measures, or deadlock affecting the viability of foreign investment in the affected blocks.

Local consultants and representatives in Africa have been making claims for commissions or success bonuses against energy and service companies. Issues sometimes arise around alleged breaches of the Foreign Corrupt Practices Act (FCPA). Well publicized FCPA allegations and concerns that sometimes arise from innuendo increase competitive pressures and introduce a layer of risk that is factored into any evaluation of a resource rich prospect in the region. As demand for energy grows, the balancing act will continue, pitting a host government’s desire to attract foreign investment against an international company’s desire to explore and develop resources in increasingly risky political and economic environments.

LATIN AMERICAThe litigation trend in Latin America shows a spike in investment dispute matters grounded on bilateral investment treaties (BITs). A government’s attempt to reassert control over oil, gas and power production and transportation/distribution is one reason. Perhaps a larger contributor, however, remains the fallout from the Argentine financial crisis of 2000-2002.

For example, CMS Gas Transmission Company won an award of $133.2 million from an ICSID (International Centre for Settlement of Investment Disputes) arbitral tribunal in 2005. The company is a minority shareholder in an Argentine company with a 35-year license to transport natural gas. Argentina had refused to adjust tariffs in accordance with the license during Argentina’s economic crisis. The tribunal concluded this was a breach of the obligation of fair and equitable treatment in the U.S.-Argentina BIT and the stabilization clauses in the license. In the end, the tribunal rejected Argentina’s defense based on a “state of necessity.”

More than 15 arbitrations were pending against Argentina at the beginning of 2007 at the World Bank’s ICSID. Eleven energy companies were among the parties involved, with claims totaling more than $8 billion.

Meanwhile, Ecuador has become one of the most frequently sued states in investment arbitrations. Various energy companies had a total of more than $3 billion in claims pending before ICSID against Ecuador at the start of 2007. They include four companies in the electricity sector (Duke Energy, EMELEC, MCI Power Group, and Machala Power) and two oil companies (Oxy and RepsolYPF). Expansion of Ecuador’s largest oil refinery, Esmeraldas, has also generated disputes before ICSID. Two Spanish construction and engineering companies (Técnicas Reunidas, S.A. and Eurocontrol, S.A.) requested arbitration in the fall of 2006.

Surprisingly, amid much publicized political change and what some would describe as at least a more difficult climate for foreign investment, the countries of Bolivia and Venezuela thus far have not been involved in the number of arbitrations generally anticipated. Many of the companies involved there have managed to reach accommodations with the governments, but obviously the strong trend toward resource nationalism and the accompanying increasing government control over resources and industries in these countries has created concern in the Americas. Venezuela has paid the recent awards against it, but the government’s agenda of nationalization of the power industry and greater control over resources in the Orinoco Belt would suggest many more investment claims ahead.

EUROPEThe London Commercial Court experienced a decrease in the number of cases from 1999 to 2005 of slightly more than 50 percent. This steep decline reflects, in part, changes to the English Rules of Civil Procedure after the Woolf Reforms (named after Lord Woolf’s 1999 recommendations for changing the civil law system), which impact proceedings before they begin and encourage mediation to facilitate dispute settlement. It also stems from the growing preference among many companies to consider international arbitration. However, in 2006, the Commercial Court recorded a 3.3% increase in the number of claim forms issued in the period up until July 31, 2006, and provisional figures for the calendar year indicate this figure has substantially increased to approximately 1,300 (a 29% increase). In recent years, there has been a progressive trend towards favoring arbitration over the court system. In the last five years, the London Court of International Arbitration (LCIA) has seen its new caseload double, while that of the International Chamber of Commerce (ICC) Court of Arbitration has remained stable over the same five-year period, despite a reduction in the 2002 to 2005 period.

However, it is not only disputes in arbitration and court proceedings that are consuming the time and budgets of corporations. Increasing regulatory inquiries, often crossing more than one country or continent, are becoming more prevalent. There is also a general trend toward developing a larger regulatory framework in several areas.

For example, competition law and regulatory powers are now being used by the European Commission to assist in the drive to open its energy market. In fact, liberalization of the energy sector has been on the European Commission’s agenda for many years. In 2003, directives were adopted establishing common rules for creating liberalized internal markets for electricity and natural gas.

In May 2005, the Commission’s director general for competition opened a Europe-wide investigation into the energy sector under two articles that provide the Commission with information-gathering tools for identifying barriers to competition. The preliminary report was published in February 2006 and outlined “serious malfunctions” in the energy market, resulting in these characteristics: “a high degree of market concentration”; “vertical foreclosure” limiting the supplies available to new companies; “lack of market integration” across member states; “lack of transparency” in access to information; and “pricing” formats where supply is influenced by political considerations and is not market driven.

In March 2006, the Commission published a green paper outlining six key strategy areas for establishment of open and competitive markets that enable European companies to compete Europe-wide. To achieve a liberalized internal market, the Commission is adopting an approach that exercises its competition law powers in parallel with its regulatory powers.

A dramatic example occurred in May 2006, when the Commission, using its inspection powers under Article 20 of Regulation 1/2003, carried out dawn raids against utility companies in six member states (Germany, France, Belgium, Italy, Austria and Hungary). The action was taken in response to complaints that the companies had acted against competition rules. The Commission is continuing to pursue these investigations.

Member states are also monitoring cross-border mergers closely, arguing that they have a wide range of domestic and strategic interests to consider. The European Commission Merger Regulation gives the Commission broad powers to deal with mergers that it considers to be incompatible with the common market.

The EU Commission’s Strategic Energy Review, published in January 2007, proposed the framework for the EU’s energy market. It will be the basis on which the European Council will formulate the EU’s future energy policy. It is an important step in creating a liberalized European energy market, which is still very much a work in progress. One thing is clear, however: The Commission has shown a determination to use the law as a tool along with political persuasion to establish a more open energy market across member states.

ASIA AND THE MIDDLE EASTContract rights are under assault by sovereign states across a broad swath of Asia and Eurasia. The most obvious example was the Russian government’s grab of Yukos Oil for the benefit of state companies, generating a string of high-stakes litigation in U.S. courts and international arbitrations.

The 5th U.S. Circuit Court of Appeals reversed a decision of the district court inBridas S.A.P.I.C. v. Government of Turkmenistan and rendered judgment against the government, holding it liable on an arbitral award of almost $500 million. This decision came about even though Turkmenistan had not signed any of the relevant contracts.

Bridas had a joint venture agreement (JVA) with a state company designated by the government. When the government wanted to increase its share of future proceeds, it ordered Bridas to halt operations and cease all imports and exports to and from Turkmenistan. Bridas initiated arbitration. The government then dissolved the state party to the JVA and formed a new company, Turkmenneft. The government also decreed that all proceeds from oil and gas exports should go to a special State Oil and Gas Development Fund, which was conveniently declared immune from seizure.

The 5th Circuit Court, in applying U.S. legal principles for piercing the corporate veil, determined, among other things, that the government’s machinations were designed to prevent Bridas from recovering any substantial damage award and therefore satisfied the “fraud or injustice” prong of this analysis. The court’s reasoning was unequivocal: “Intentionally bleeding a subsidiary to thwart creditors is a classic ground for piercing the corporate veil.”

There were similar aspects apparent in the arbitration between Petrobart Limited (Petrobart) and The Kyrgyz Republic (Kyrgyz) at the Arbitration Institute of the Stockholm Chamber of Commerce. Petrobart had a contract to sell 200,000 tons of gas condensate to a state company, KGM, which failed to pay for three deliveries under the contract. The government then restructured its state energy sector, transferring assets out of KGM while the debts remained with the company.

The arbitral tribunal determined that Petrobart was an investor under the broad definition of investment in the Energy Charter Treaty (ECT) and ruled that Kyrgyz had breached its treaty obligation of fair and equitable treatment. Petrobart was awarded damages, estimated at 75% of the company’s justified claims against KGM, which amounted to approximately $1.1 million plus interest.

On Sept. 27, 2007, Kazakhstan’s Parliament passed legislation which will enable the government to alter the terms and conditions of contracts with subsoil (the layer of soil under the topsoil) users when the contract is deemed to adversely affect the national security of Kazakhstan and its economic interests. Failure of the subsoil user to agree to conduct negotiations, reach a new agreement or sign a new agreement will give the government the right to terminate the contract. This new law applies retroactively and thus has the potential to affect all existing oil contracts.

Companies operating in China have also experienced tough renegotiation approaches by the government. The Chinese government forced at least one major oil company to submit to arbitration by imposing a windfall-profits tax in 2006, despite stabilization commitments in state petroleum contracts. Generally, claims by international energy companies in Asia have moved upstream recently to oil and gas projects. Previously the focus of most disputes in the region had been downstream power projects.

Even in the Middle East, some states have put their performance of agreements in question. Two international oil companies commenced an ICC arbitration in late 2005 against a government for that very reason. The matter involved an agreement extending the production-sharing agreement on an offshore block.

Overall, the temptations of a booming global economy inevitably lead to a desire by parties of all types and sizes to seek a larger piece of the vastly growing pie. They may be individual consultants and representatives with or without ties to host governments, companies involved in cross-border operations and transactions, or state entities. The result naturally is a complex and expanding web of disputes, a trend that is likely to continue.

About the Author: William D. Wood is a partner in the Houston office of Fulbright & Jaworski. He is co-chair of the firm’s energy litigation, international litigation and Latin America practice groups. Lista M. Cannon is the partner-in-charge of Fulbright’s London office. Her practice focuses on energy contract disputes, transnational litigation and regulatory enforcement, investigations and proceedings.