executive-lawyer-boardroomAccording to Taverne, the production sharing contract (PSC) is the oldest form of risk contract and has been utilised within the petroleum industry for over 25 years. Against this backdrop are the aims of the parties when entering into these types of agreements. In terms of mineral development the main aim of the multinational firm is profit maximisation whereas the government of the host country is mainly interested in maximising its revenue. These different aims arise from the fact that the State is saddled with the responsibility of ensuring that the public interests of the State’s citizens are protected in terms of any agreement entered into with regard to the State’s natural resources. This may mean that due to varying considerations the State may subsequently want to alter the agreement to secure a better position for its citizens. On the other hand, the multinational will want to ensure that when it enters into negotiations over the agreement, it does so under favourable conditions. Furthermore, due to the long term nature of production sharing contracts, it is only natural that the multinational will want to maintain those favourable conditions that were established at the time the parties entered into the agreement. As such, Bernardini in his article Stabilization and Adaptation in Oil and Gas Investments notes that stabilization and renegotiation clauses are the main ways by which the State and the multinational can achieve the ‘…common objective to allocate between them the risk inherent in a long-term transaction’ such as a production sharing contract. This article will take a look at these stabilisation and renegotiation clauses, assess their functions and comment on the problems that they may face in relation to their ability to achieve the parallel aims of protecting the public interest and the multinational’s investment.

Stabilisation Clauses

Maniruzzaman, in the article Some Reflections on Stabilisation Techniques in International Petroleum, Gas and Mineral Agreements states that Stabilisation clauses are meant to act as a means of safeguarding the interests of the multinational by restricting any legislative or administrative powers of the State aimed at the unilateral modification or termination of the substantive original agreement entered into by the parties without the prior consent of the multinational. Bernardini further points out that the intended effect of this clause, sometimes known also as the intangibility clause, is such that the law applicable to the agreement will always be ‘…the law of the host State in force at the time of the conclusion of the contract, thus excluding the applicability of any future laws and regulations’. Thereby essentially ‘freezing the law’ and ensuring that favourable conditions which encouraged the multinational to invest in the State’s reserves are preserved in perpetuity.

The economic, political, fiscal and regulatory risks and considerations which are shared by the multinationals and their project financiers alike have been the main catalysts for the proliferation of this provision in such agreements so as to ensure adequate protection of their investments. However, it must be noted that there may be problems inherent in relying on stabilisation clauses alone to achieve this aim. One important reason for this conclusion is the enforceability of stabilisation clauses in international law under specific circumstances. Bernardini highlights the fact that ‘the effectiveness of such provisions may be doubted whenever they purport to limit the States’ inalienable prerogatives, as it would be the case of a stabilization clause providing for the prohibition of nationalization or expropriation’. This is further corroborated by Jean-Marc Loncle and Damien Philibert-Pollez in their article Stabilization Clauses in Investment Contracts in which they state that ‘…the enforceability of a stabilisation clause may nevertheless fail if new legislative or regulatory measures adopted are tools in a lawful nationalisation programme having regard to international law’. Thus, it is possible to argue that these clauses may not always be enforceable depending on the particular type of public interest involved.

Another problem which is also related to this issue of enforceability is one of agency. This refers to the question of whether the State entity is acting on behalf of the State or whether the State entity is an alter ego and thereby acting in the capacity of the State when it enters into an agreement with the multinational. This is important as it is necessary to determine the actual party that is intended to be bound by the clause due to the possibility of States putting forward the argument that they are not privy to contracts entered into by State Oil Companies and multinationals as has been the case in certain instances (See the case of Amoco International Finance Corp v Iran (1987 II) 15 Iran-USCTR 189 for an example of this).

In addition, it must also be noted that despite the fact that there has been a move by most States in recent times towards the recognition of international dispute resolution, multinationals still need to be cautious of the fact that in certain instances, it may still be the case that the State will insist that issues relating to stabilisation clauses be subject to the jurisdiction of the State’s legal framework in terms of dispute resolution. As such, with the absence of an international forum for dispute resolution there may be a lack of urgency on the part of the State to fulfil its obligation under the agreement since it is confident of prevailing over the multinational in the event of any conflict arising under the stabilisation clause. To a lesser extent another problem which may be attributed to stabilisation clauses is one of ensuring properly drafted clauses that comprehensively take into account the issue of ‘mutual consent’ of the parties required for the clause’s amendment and how this is to be determined.

From the above, it could be said that numerous problems exist with regard to the enforcement of the stabilisation clause. As such, a better option might be to seek the inclusion of a renegotiation clause to the agreement. It is appropriate at this point to move on to a full discussion of renegotiation clauses.

Renegotiation Clauses

According to Gotanda in his article Renegotiation and Adaptation Clauses in Investment Contracts, Revisited, ‘renegotiation clauses are provisions in contracts that, upon the happening of a certain event or events, require all parties to return to the bargaining table and renegotiate the terms of their agreements’. They have been suggested as better alternatives to stabilisation clauses as they appear to achieve the dual aims of ensuring that a State’s sovereign right remains intact by allowing it to make decisions that may affect the agreement and at the same time provide protection to the multinational’s long term investment by allowing it to renegotiate the terms of the agreement subject to these decisions. Bernardini however, indicates that renegotiation may also occur at the instance of the State as well as the multinational and also that the clause can be triggered by supervening events beyond the control of the parties, which could negatively affect the agreement to the detriment of either party.

The ultimate aim is to create a flexible yet stable agreement which is capable of adapting to any changes in the law, regulations, economy or other circumstances which may affect the parties. Nwete in the article To what extent can Renegotiation Clauses achieve Stability and Flexibility in Petroleum Development Contracts? also contends that renegotiation offers the parties an early opportunity to resolve any differences which could eventually lead to disputes. Thereby saving costs attributable to dispute resolution mechanisms and also preserving the benefits of ongoing contractual relationships in the process. He goes further to state that ‘its other roles and importance include offering the parties an opportunity to complete an incomplete contract by filling in the gaps and enabling them to allocate unenvisaged risks while sharing unanticipated profit’.

However, as Gotanda notes, renegotiation clauses are not without their own limitations. An issue which could arise is that of uncertainty with regard to the agreement. This could occur due to the fact that generally drafted renegotiation clauses could encourage the parties to ask for renegotiation on ridiculous grounds. Associated to this problem of uncertainty is the issue of what amounts to a ‘trigger event’? The question remains as to whether a minor impact caused by a change in law would be enough to trigger off renegotiation. Furthermore, the stability and predictability of the terms of the agreement would no longer exist, as the multinational’s obligations to them would always be the subject to the results of future renegotiations.

Another issue which could arise is; who decides when a trigger event has occurred and that the balance between the parties has changed? There is the danger that if this is left within the control of the State, there is a possibility that it may be utilised in an unfair manner to alter the agreement. Furthermore, Gotanda states that it is arguable to say whether a ‘dispute’ would exist despite the fact that the parties have failed to successfully renegotiate the terms of the agreement. As such any referral to an arbitration panel could be deemed futile as it may claim that it lacks jurisdiction to entertain the matter. Berger in his article Renegotiation and Adaptation of International Investment Contracts: The Role of Contract Drafters and Arbitrators’ further highlights that assuming the arbitration panel does entertain the ‘dispute’, the clause may not provide adequate guidance in terms of which the panel can modify the terms of the agreement. As such it gives the panel the freedom to review or rewrite the agreement in a manner that is inconsistent with the parties’ intentions. Finally, there are high costs associated with contract renegotiations as they increase the cost of transaction and contribute to a loss of man-hours.

Stabilisation Clause or Renegotiation Clause?

Hence, we have seen from above that both stabilisation and renegotiation clauses are the main ways by which a balance is sought to be struck between the two extremes of stability and flexibility in long term production sharing contracts. We have also seen that each is faced with its own plethora of problems with regard to the suitability of attaining this delicate balance. Several possible solutions to each have been thrown up by various scholars with regard to the issues facing both types of clauses as highlighted above. However, it must be noted that another possible solution may lie in utilising ‘hybrid stabilisation clauses’ which contain elements of stabilisation and renegotiation/adaptation clauses in a single clause and to ensure that in its drafting, adequate provision is made in terms of setting time limits for renegotiations and also what should trigger referral to arbitration. Furthermore, as an extra measure, the agreement should be made part of the laws of the host State through the enactment of a special law granting supremacy to the provisions of the agreement. This in effect, makes the agreement superior to the domestic laws of the host State. However, the potential successes or failures of these measures will need to be discussed in another forum.


*Noma Garrick is a lawyer and consultant with extensive experience in oil and gas and energy related matters.