Thursday, June 21, 2012

HOST COUNTRY vs IOC: Types of Stabilization Clause

By Tarek Ghaleb
Freezing provision. 

The freezing stabilization clause is considered to be the most familiar type of the stabilization clause. The freezing clause may limit HC’s (Host Country) sovereignty right, power to issue new legal acts or change the norms of applicable laws with respect to the petroleum project under IPA (International Petroleum Agreement) that contains these stabilization provisions. Thus, the investor may rely upon provided guarantees under the clause that HC will not change or add more obligations within the frameworks of the IPA, because the freezing clause limits the power to change or issue new acts of legislations, which are related to the contractual relationship of IOC and HC, which is based on the IPA. By adding the freezing type of the stabilization clause in to the IPA any changes of issuing new legislation which after the effective date of the IPA will not be applied on the IPA[1]

The freezing clause does not prohibit the HC to issue or change its domestic laws. It will only act 
 as a shield in order to protect the investor from any changes or introducing new legislations which are considered as a unilateral action by the HC. This change or new legislation which occurred after the effective date cannot be applied on the IPA. Obviously all the laws and regulations which were already existing before the effective date of the IPA will be applied on the IPA[2].The freezing clause plays an important role especially when the governing law in the IPA is the domestic laws of the HC. In this case the freezing clause applies limitation to the power of the HC with which it can modify the terms and the conditions of the IPA by changing the local laws. The mechanism of the freezing clause can be consider as a kind of wavier of the sovereignty of HC in terms of modifying the terms of IPA[3]

The freezing clause is considered as the traditional type of the stabilization clause. There are several different kinds of this traditional stabilization clause: the stricto senso clause, the intangible clause, and the hybrid clause[4]

The stricto senso clause stipulates that the applicable laws regarding a specific IPA are only the laws, which were applied at the time of signing the IPA. Any laws, which are adopted after signing the IPA, cannot be applied on this IPA; thereby no new laws can affect the IPA during all lifespan of this IPA[5]

An example of the stricto senso clause can be found in the Tunisian petroleum model contract for the year 1989, which states: 

“The Contractor shall be subject to the provision of this Contract as well as to all laws and regulations duly enacted by the Granting Authority and which are not incompatible or conflicting with the Convention and/or this Agreement. It is also agreed that no new regulations, modification or interpretation which could be confliction or incompatible with the provision of this Agreement and/or the convention shall be applicable”.[6]

The second kind of the traditional stabilization clause is the intangibility clause. This clause prevents the HC from amending or terminating IPAs unilaterally. The intangibility clause stipulates that any modification or termination to IPA should be agreed before by the parties to this IPA. Thus without consent of IOC, the HC cannot exercise in its full scale the sovereign power to regulate unilaterally all activities of investors in HC’s petroleum sector, through domestic legislator that require appropriate adaptation of IPA.[7]

The oil concession of 1948, what was granted to the American Independent Oil Company – AMINOIL by the Kuwaiti Sheikh, contains the following intangibility clause: 

 “The Sheikh shall not by general or special legislation or by administrative measures or by any other acts whatever annul this Agreement except what provided in Article 11. No alteration shall be made in the terms of the Agreement by either the Sheikh or the Company except in the event of the Sheikh and the company jointly agreeing that it is desirable in the interest of both parties to make certain alterations, deletions or additions to this Agreement”.[8]

The third kind of the traditional stabilization clause is considered as a combination between the stricto senso clause and the intangibility clause, and it is called the hybrid clause.[9] A good example of this kind can be found in the concession agreement between LIAMCO and Libya Arab Republic which is mentioned above. 

Economic – Equilibrium Clause: 
The economical equilibrium clause is considered as the modern kind of the stabilization clause. It has been in use commonly after the doubt of enforcing the freezing clause. Since it provides a different mechanism than the freezing clause, there are no doubts about the issue of its enforceability. The economic equilibrium clause does accept the changes in the terms and conditions of IPA that can be made due to the changes of the laws and regulations in the HC; but its role is to make sure that these changes in the laws and regulations will not affect on the expected economical benefits of IOC under IPA with this HC.[10]

The idea of the provisions is that the parties to the contract, the HC in particular, have to conduct economic equilibrium of all provisions of petroleum contract in its initial condition. Thus any changes in domestic laws, which occur after the singing of the contract and within the whole life term of the contract, do not have to cause any disbalance in the contract. Unlike in freezing stabilization provisions, host government can apply changes, amendments in laws or new laws with respect to the contract, but the government has to preserve and/or indemnify IOC from and/or against any negative outcomes. To preserve from negative outcomes are meant to prevent from IOC’s any additional, unexpected initially costs that may affect negatively on financial site of petroleum project under the contract. In other words it means to protect the economics of this petroleum project during the life term of the IPA, under which the project is implemented. To indemnify against negative outcomes means that the HC has to bear the additional costs as the result of the implementation of the news laws. The scale of the indemnification obligations of the HC under the stabilization provisions depends on the consent of the parties to the contract and the outcomes of their negotiations after the event that triggers the clause occurs[11]

If the HC decided to change the laws and regulations in such a way that it will reflect an impact on the IPA, the economic equilibrium clause in the IPA can treat this issue in three methods. The first method, that the change can be automatic which is mentioned in the IPA in order to make an economic balance. The second method is to make the changes depending on the agreement of the both parties which are the HC and IOC. The third method is to determine these changes by giving a time for the parties to negotiate the adjustments[12]

Moroccan Model Petroleum Agreement for the year 2006 contains stabilization provisions,
 which role is to restore economic equilibrium of petroleum contract as it has to be on the date of singing of the contract, in case due to specific circumstances the equilibrium has been breached: 

“the economic terms and conditions which will apply to (contractor) for the activities to be conducted by (Contractor) under this Petroleum Agreement and throughout its period of validity, have been agreed after negotiation in good faith on the basis of the legislation in force in Morocco on the date of signature. 

In the event that a change in Regulations has a significant adverse effect on the economic benefits that (Contractor) for such adverse effect. 

…. (Ministry) shall use every effort with the STATE to preserve or re-establish in favor of (Contractor) the economic terms and conditions prevailing at the time of signature. If despite the efforts of (Ministry), this should not prove to be possible, (Contractor) shall notify in writing to (Ministry) a proposal for the necessary changes effect, and the Parties shall endeavor to agree on such changes to the terms hereof. 

If the Parties fail to agree on such changes within a term of sixty (60) days from the date on which (Contractor) delivers a notice on this regard to (Ministry), the matter may be referred to Arbitration……”.[13]

This is the second installment of Takek's analysis on The Efficacy of Stabilization Clause. In the first installment he outlined the general concept of a stabilization clause and has now built on that analysis by introducing us to the types of stabilization clauses in use. This is particularly instructive for commercial lawyers who may not be aware of the intricacies in advising their clients and business units on various options for working with IOCs or NOCs and Governments- as applicable. In the next instalment, Tarek will discuss Political Risks associated with International Petroleum Agreements. For more information about Tarek and to view his professional profile, Click here -->

[1] Supra Note 1. Pg 70
[2] Supra Note 6 Pg 342
[3]  H , Inadomi  (2010). Independent Power Project in Developing Countries : Legal Investment Protection and Consequences for development . Netherlands : Kluwer Law International. Pg 115-116.
[4] Supra Note 6 Pg 105 – 106
[5]  A. Faruque. ‘Validity and Effieacy of Stabilisation Clauses : Legal Protection vs. Functional Value’ , Journal of International Arbitration 23, no.4 (2006) : Pg 317 , 319
[6] Art 24.1,  Model Production Contract (1989),
[7]Z,  Alqurashi. (2005). International Oil and Gas Arbitration. Oil, Gas & Energy Law Intelligence (OGEL) . 3,  Pg 181.

[8] Art 17, of the Oil Concession between the Kuwait Sheikh and the American independent oil company (Aminoil), 1948.
[9] Supra Note 19. Pg 182
[10] Supra Note 6. Pg 343
[11] F ,  Alexander. (2009). Comment on articles on stabilization by Piero Bernardini, Lorenzo Cotula and AFM Maniruzzaman. Journal of World Energy Law & Business. Volume 2 (Issue 3), p. 243-258.
[12] Supra Note 1. Pg 75.
[13] Model Petroleum Agreement (2006)

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