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Stabilisation clauses for international oil firms: implementation and enforcement

Out-Law Analysis | 28 Jul 2015 | 11:42 am | 4 min. read

FOCUS: Many commentators predict that the lower oil prices following the crash of 2014-15 are not likely to return to previous highs anytime soon, therefore putting more and more petroleum contracts between international oil companies (IOCs) and host states under stress. Stabilisation clauses can give IOCs a means of protecting their interests in these circumstances.

Earlier this year the Iraqi federal government issued a formal letter to IOCs operating in Iraq requesting that they "suggest modifications" to their contracts. The letter noted that "plans drawn up in the '$100 world' are no longer viable in a '$50 or less world'". Iraq is not the only host state to have signed deals on the basis of an oil price of $100 a barrel that will inevitably be looking to secure additional revenues, possibly through the exercise of sovereign power to change the laws governing host state revenue from petroleum contracts.

We have already looked at the different types of stabilisation clause that IOCs may be able to negotiate to mitigate or manage the economic risks of law changes by a host state. It is important also to consider the implementation of stabilisation clauses, and the extent to which they may be enforced.

Enforceability under domestic law

Constitutional issues

One of the main issues to consider in relation to enforcement of a stabilisation clause is whether, under the constitutional laws of the host jurisdiction, the host state is able to bind itself in this way. This may be particularly relevant in the case of freezing clauses, which effectively limit the host state's sovereign power to amend and update its laws.

The prevailing view of legal commentators is that economic equilibrium stabilisation clauses are less likely to be successfully challenged as unconstitutional, since the host state retains unfettered legislative authority. However, this may not always be the case and the terms of the stabilisation clause will need to be considered carefully in the context of the constitution and applicable domestic laws.

It is not uncommon for petroleum contracts to be enshrined into law by an act of the host state's legislature or decree by the executive; thereby elevating the contract and the stabilisation clause within it up the hierarchy of norms within the constitutional system. However, even legislative or executive ratification of a petroleum contract cannot provide an IOC with absolute certainty that it can enforce the clause, as there is always the possibility of the contract being held unconstitutional by the judiciary or overturned by a subsequent act of the legislature or executive.

Interpretation of laws

Another practical issue can arise in the case of freezing clauses if the IOC cannot prove that there was a stable interpretation of the law at the effective date of the petroleum contract. This can be a particular problem with full freezing clauses, which freeze the state's entire body of laws at the effective date of the contract; but even where the parties have identified a limited number of laws to which the freezing clause will apply, the issue remains that it might be difficult for the IOC to prove an established interpretation at the time of the alleged breach.

This is particularly the case in jurisdictions where, for example, retention of records is poor or an official journal is not easily accessible; where the legal regime is in flux; or where the applicable law is a 'framework' law intended to be supplemented with yet-to-be-enacted enabling legislation. Whether the issue is interpretation or legality under domestic law, an IOC will undoubtedly benefit from thorough due diligence of the domestic and constitutional law of the host state.

Authority

IOCs must also be alert to issues of authority. Some jurisdictions do not recognise, or recognise to a lesser extent, the concepts of agency and implied authority. Therefore, it is important for the IOC to understand which host state entity is entering into the petroleum contract and whether the relevant minister or official signing the contract has actual authority to sign. This may be particularly important where subsequent governments of the host state are seeking to unwind the actions of the previous government.

Public interest considerations

It is important to note that under some jurisdictions, where compensation for a change in law might be considered as a punitive measure or not in the public interest, then enforceability of a stabilisation clause may potentially be challenged under domestic law. An interesting example occurred in Uganda recently, where the text of a stabilisation clause in a contract with Tullow Oil was ultimately amended as it was perceived as undermining the development of human rights and social welfare in the country and was therefore contrary to the public interest.

To mitigate such risks, a negotiator might refer to 'soft law' standards such as the UN Guiding Principles on Business and Human Rights when drafting and negotiating a stabilisation clause.

Enforceability under international law

When considering the enforceability of a stabilisation clause, it is also important to consider whether international law provides either party with an additional avenue for, or defence against, enforcement of a stabilisation clause.

The prevailing doctrinal view is that a breach of contract does not normally create a wrong that can be remedied at international law. It is commonly accepted that regulation which diminishes the value of an investment contract is not illegal. However, expropriation which is discriminatory – that is, which targets a group such as a particular race – or that it deemed arbitrary and not for the public good can potentially be elevated to a claim under international law.

Therefore, assuming that the contract has been validly entered into and is enforceable, the IOC's remedy for breach of a contractual stabilisation clause will be via the domestic law of the host state.

Although not considered in these articles, IOCs should also be aware of their rights under the many international investment agreements that exist between and among states. The most well-known of these are probably bilateral investment treaties, although multilateral investment treaties and free-trade agreements can offer similar protections.

George Booth, Niazi Kabalan and Leo Shaw are experts in international oil and gas projects at Pinsent Masons, the law firm behind Out-Law.com.

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