Rise in arbitration in the extractive industries

The rise in commodity prices increased popular expectations, and governments accordingly came under pressure to show that citizens would receive greater benefits as a result of the rising resource revenues.  In the face of growing uncertainty about future prices and demand, however, extractive companies started to face pressure from their shareholders to scale back, delay or even cancel projects.  Governments were therefore seeking to benefit from windfall profits during price spikes, whilst on the other hand the companies wanted the ability to delay or downsize the project during a downturn.  Unfortunately, many contracts did not provide the flexibility required; the Chatham House report notes that model contracts of the 1990s have by and large failed to weather the commodities price boom.

For the purposes of its report, Chatham House carried out an analysis of disputes and the arbitration data available, looking for patterns and indicators that might help identify the drivers and conditions for company-government disputes in the extractive industries.  Whilst it found it difficult to draw robust conclusions to help identify expropriation- or arbitration- prone countries, it did identify key drivers of disputes, namely "resource nationalism", tensions with local communities, and environmental issues.     

"Resource nationalism" is a popular concept generally used to refer to moves by producer countries to gain greater control of their country's resources.  It is more likely to become a problem in cases where the initial deal struck with the government is perceived as unfair by local communities:  this will increase the risk that the government will come under pressure from stakeholders to renegotiate the deal or even renege on its agreement at a later stage.  

Stéphane Brabant (co-head of the Business and Human Rights Group as well as the Mining Group at HSF), recently attended the Second Annual United Nations Forum on Business and Human Rights in Geneva to discuss the implementation of the UN Guiding Principles on Business and Human Rights at the international and national level by States and companies.  At the breakfast panel session hosted by Herbert Smith Freehills (HSF) on 5 December 2013 to mark the publication of a new report by the McKinsey Global Institute (MGI), "Reverse the Curse: Maximizing the potential of resource-driven economies", he noted that companies are waking up to the connection between the upholding of human rights and shareholder value.  Indeed, breaches of such "soft law" principles can lead directly to "hard" sanctions as well as potentially serious reputational damage. 

An audience participant at the breakfast seminar noted the importance of flexibility in contractual arrangements to ensure the sustainability of a deal.  He also commented on the importance of effective communication to ensure that a fair deal is appropriately perceived as such by all stakeholders.  This is an important theme of the MGI report, which stresses that effective communication with the government and local stakeholders is key at all stages: before the deal is struck, when it is crucial to understand their objectives and address potential future concerns; during operations, to manage expectations and make local stakeholders aware of the importance of the company's contribution to the local economy; and when projects are likely to be delayed or cancelled, to make the host government aware of the potential downside of attempts to renegotiate deals or expropriate assets.

Many deals will need to be renegotiated.  In West Africa, for example, where mining contracts and codes are being opened to public scrutiny as part of initiatives such as the Extractive Industries Transparency Initiative (EITI), governments are under pressure to renegotiate contracts and review their mining codes, and various reviews of the sort are already under way in Guinea, Sierra Leone, Mali, Liberia and Ghana. 

In many cases, companies and governments will be able to come to a new agreement, cooperating to ensure that the host country's legitimate policy concerns are addressed and a strong and stable legal framework is put in place for their deals.  Where governments make sudden changes in the terms of investment, acting under pressure to offset societal unrest or to drum up political support, however, it may not be possible to reach a mutually acceptable compromise.  In such circumstances, companies may need take a hard line and be willing to resort to arbitration against a host government for reneging on an agreement or changing its provisions, not least as an important precedent for future disputes.  The MGI report cites the example of ExxonMobile, which was able to recoup roughly USD300 million in 2007 after its assets in Venezuela were expropriated.

Although commodity prices are now falling, according to the Chatham House report, disputes between resource groups and governments are only likely to keep increasing as companies start reducing their capital expenditure and come under pressure to renegotiate their contracts with host governments or lose their licences as a result.  HSF has extensive experience in advising companies on crisis management and dispute resolution in the mining sector.  Companies may wish to get in touch to obtain specialist advice on the options available to them if they have any concerns regarding their mining deals.   

For more information, please contact , Matthew Weiniger, Partner, Naomi Lisney, Associate, or your usual Herbert Smith Freehills contact.