Dispute Resolution Mechanism under the Lebanese Model Exploration and Production Agreement

DISPUTE RESOLUTION MECHANISM UNDER THE LEBANESE MODEL EXPLORATION AND PRODUCTION AGREEMENT

By:  Mohamed Alem and Mazen Ghosn

Introduction

The Lebanese Cabinet issued on 19 January 2017 Decree number 43, annex 2 of which consists of a model Exploration and Production Agreement for petroleum activities (“EPA”).  In brief, the EPA acts as a Production-Sharing Contract by virtue of which the Lebanese State retains ownership of the underlying natural resources and compensates the investor (or group of investors) with a share of the production.

As a complex, capital-intensive and long-term arrangement involving resources that are often the subject of surpassing political and sovereign concerns, Production-Sharing Contracts such as the EPA have frequently been the subject of international commercial and state investment disputes.  Revealingly, with 25% of all cases registered under the ICSID Convention and Additional Facility Rules, “Oil, Gas & Mining” disputes represent the bulk of ICSID cases.[1]  Similarly, 13% of the disputes registered in 2016 under the Arbitration Rules of the ICC relate to the energy sector.[2]

Disputes are therefore a significant risk in any international energy project, and the extraction of oil and gas in the offshore reservoirs of the Lebanese Exclusive Economic Zone is not exempt from such risk.  To be clear, the risk is not whether a project will be subject to a dispute, but rather how well the parties can manage that dispute.  Undeniably, areas of risk related to dispute management are directly correlated with the wording and structure of dispute resolution mechanisms found in Production-Sharing Contracts.  The aim of this note is to evaluate whether the dispute resolution mechanism provided in the EPA allows for an efficient management of any potential disputes that may arise therefrom.

Parties to the dispute

As indicated above, it is anticipated that the Lebanese State enters into the EPA with a group of investors, also known as Right Holders.[3]  Pursuant to its Article 4(3), the EPA “shall have no fewer than three (3) Right Holders at any time”.  Article 6 of the EPA also adds that the Right Holders shall be deemed to have formed an unincorporated Joint Venture and their obligations under the EPA and in respect of all Petroleum Activities shall be treated as joint and several.

Taking into consideration the above, one commentator was of the view that the dispute resolution mechanism under the EPA ought to reflect this multi-party reality.[4]  According to this commentator, “[i]f an EPA defines the rights holders collectively and inseparably as a ‘party’, there will be a potential risk that locus standi will be denied to an individual rights holder in the event that it seeks to invoke the EPA’s dispute resolution provisions and the remaining parties to the unincorporated joint venture are neither willing nor obliged to participate”.

We do not entirely share these views for the following reasons: First, whilst the EPA contains provisions governing joint and several obligations of Right Holders as parties to an unincorporated Joint Venture, the Right Holders are treated as “Parties” to the EPA each in its own individual capacity.  It follows that, as contractual party to the EPA, each Right Holder will have locus standi in the event that it seeks to invoke the EPA’s dispute resolution provisions notwithstanding whether the remaining Right Holders are neither willing nor obliged to participate.  Second, even when assuming that only the unincorporated Joint Venture is to be treated as “Party” to the EPA, the Right Holders would not be deprived from their right to seek remedy under the EPA owing to the “Majority Rule” under Lebanese corporate law, and to derivative actions available to shareholders.  In application of the “Majority Rule”, in the event that an individual Right Holder is a majority shareholder in the unincorporated Joint Venture or can cause the majority of shareholders to vote in a specific direction, the remaining Right Holders cannot then prevent the unincorporated Joint Venture from invoking the EPA’s dispute resolution provisions.  As for derivative actions available to shareholders (also known as “action sociale ut singuli”) – these actions allow, inter alia, shareholders (such as an individual Right Holder who is unable to cause the unincorporated Joint Venture to seek remedy under the EPA) to initiate legal proceedings on behalf of their company against the company’s management when the latter has failed to bring suit.  Third, and in any event, the solution to any potential deadlock arising from this multi-party reality does not lie within the dispute resolution mechanism provided in the EPA, but rather within a shareholder/parallel agreement to be entered into by the parties to the unincorporated Joint Venture.

Pre-arbitral procedural requirements

Pursuant to Article 37 of the EPA, “[a] dispute shall be resolved, if possible, by negotiation between the Parties […]”.  The question that arises from this provision is whether pre-arbitral negotiations are mandatory in the EPA or merely optional.  The importance of this question pertains to the utility of holding good faith talks prior to initiating arbitral proceedings and, more importantly, to the consequence of non-compliance with negotiation as pre-arbitral procedural requirement.

International arbitration agreements frequently impose pre-arbitration procedural requirements that apply prior to commencement of arbitral proceedings.[5]  Among other things, these provisions often require good faith negotiations between the parties to resolve their disputes.[6]  These provisions are designed to enhance the efficiency of the arbitral process, by encouraging amicable dispute resolution and avoiding unnecessary proceedings and expense.  For pre-arbitral procedural requirements to be mandatory, the language of the governing provisions needs to be very clear to this effect.  But even in that case, a question still remains as to whether pre-arbitral procedural requirements constitute jurisdictional bars to the initiation of arbitral proceedings, or should instead be regarded as matters of admissibility or procedure, that are capable of cure and whose breach does not ordinarily preclude resort to arbitration.

In the case of the EPA, and in spite of the confusing language contained in the first sentence of Article 37,[7] we are of the view that negotiation is a mandatory pre-arbitral procedural requirement under the EPA.  The reasons for this are the use of the term “shall” in Article 37, and the fact that the EPA requires negotiation for a specific period of thirty days, following which the Parties are to settle their dispute by way of arbitration or expertise (as will be seen below).  As for non-compliance, considering the divergent decisions by arbitral tribunals, courts, and other authorities on the characterization of pre-arbitration procedural requirements,[8] the legal consequences of breaches of the requirement to negotiate under the EPA are uncertain.  For that reason, it is our view that any party wishing to settle a dispute under the EPA, ought first to attempt resolving said dispute by negotiation for a period of thirty days.

 

Available avenues for dispute resolution

In the event that negotiation fails, the EPA provides that “either Party shall have the right to have such dispute determined by arbitration or a sole expert as provided for in this EPA.”  The EPA further specifies that “save for any matter to be referred to a sole expert pursuant to the provisions of this EPA, the Parties shall submit any dispute […] to binding arbitration […]”.  On reading the foregoing provisions, it appears that the settlement of disputes through an expert or by way of arbitration are mutually exclusive.  There is no doubt that the mutual exclusivity of the available forums prevents the adverse consequences of parallel proceedings in front of competing jurisdictions.  But the question remains whether the EPA’s available avenues for dispute resolution are truly mutually exclusive.  This cannot be the case insofar as an expert determination is not enforceable per se.[9]  In effect, whilst the EPA refers to the decision of the sole expert as “final and binding”, it however directs the party to arbitration for the purpose of “compelling compliance with such decision or seeking damages from any lack of compliance”.  It is reasonable to assume in such case that the unsuccessful party may then seek to resist the making of such a declaration or order on the basis that the arbitral tribunal should not, in its discretion, enforce the expert determination.  Whatever the case may be, it arises from the foregoing that, where the EPA provides that a sole expert shall issue a determination on a specific matter, the settlement of disputes through an expert or by way of arbitration are not truly mutually exclusive as much as they are consecutive.  And whilst the expert determination may reduce the time and costs of any subsequent arbitral proceedings, there is always the risk that the challenging party succeeds in dragging the claiming party in lengthy proceedings in the hope of revisiting the expert findings.[10]

Another issue arising from the available avenues for dispute resolution is the possibility to appeal an arbitral award issued in connection with the EPA.  It is indeed a matter of Lebanese law, in domestic arbitration,[11] that arbitral awards may be appealed unless the parties have expressly waived their right to do so.[12]  In this respect, the EPA provides that “[a]rbitration and sole expert determination as aforesaid shall be the exclusive method of determining a dispute pursuant to this EPA.”  Whilst we are of the view that the foregoing provision amounts to a waiver by the parties of their right for appeal, it remains, however, that the wording used could benefit from being redrafted in more explicit terms so that no future disputes arise in relation to the possibility of appealing arbitral awards issued in connection with the EPA.

 

Conclusion

In light of the foregoing, we are of the view that no apparent situation of deadlock could reasonably arise from the dispute resolution mechanism provided in the EPA.  Nonetheless, for the reasons explained above, we consider that some of the EPA provisions could benefit from being redrafted in clearer terms so to ensure that potential disputes arising from the agreement progress efficiently.

 

[1]               The ICSID caseload statistics, Issue 2017-1, p.12.

[2]               ICC dispute resolution bulletin 2017, Issue 2, ICC practice and procedure, p.113.

[3]               The 2010 Offshore Petroleum Resources Law defines Right Holders as “[a]ny joint stock company which is participating in Petroleum Activities pursuant to this law through an Exploration and Production Agreement or a Petroleum License that permits it to work in the petroleum sector.”

[4]               Z. Obeid, Model exploration and production agreement: dispute resolution in the face of divergent interests, 16 June 2016.

[5]               See Klaus Peter Berger, ‘Law and Practice of Escalation Clauses’ (2006) 22 Arb Int’l 1.

[6]               See Simon Chapman, ‘Multi-Tiered Dispute Resolution Clauses: Enforcing Obligations to Negotiate in Good Faith’ (2010) 27 J Int’l Arb 89.

[7]               It is indeed not entirely clear whether the mention “if possible” relates to negotiation or to settlement by way of negotiation. In the first case, this would suggest that negotiation is a mere option depending on whether or not it is possible to negotiate.

[8]               Compare Burlington v Ecuador, ICSID Case No ARB/08/5, Decision on Jurisdiction (2 June 2010), para 315, Murphy Exploration v Ecuador, ICSID Case No ARB/08/4, Award on Jurisdiction (15 December 2010), para 149, Wintershall v Argentina, ICSID Case No ARB/04/14, Award (8 December 2008) para 116, with Hochtief AG v Argentina, ICSID Case No ARB/07/31, Decision on Jurisdiction (24 October 2011), para 96, Telefónica SA v Argentine Repub, ICSID Case No ARB/03/20, Award on Jurisdiction (25 May 2006), para 157.

[9]               To obtain the fruits of a successful expert determination, a party must commence proceedings in a court of competent jurisdiction for a declaration or order for specific performance of the agreement by which the parties agreed to the resolution of the dispute by Expert Determination.

[10]             This is all the more the case given the very tight timeframe and during which the sole expert is expected to issue a determination under the EPA.

[11]             Notwithstanding the debate about the nationality of Lebanese incorporated companies owned or controlled by foreigners, it is anticipated that some of the Right Holders will be solely Lebanese. In such case, disputes between them and the Lebanese State under the EPA would qualify as domestic arbitration seeing as no cross-border flow would have taken place.

[12]             Article 799 of the Lebanese Code of Civil Procedure.