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The Guide to Energy Arbitrations - Second Edition

The Challenges Going Forward

06 June 2017

In the foreword to the first edition of this book, Andrew Clarke of ExxonMobil International sets out the costs and benefits of arbitration in the oil and gas world. It is worth repeating:

While it is by no means perfect, international arbitration has become the primary mechanism by which disputes are resolved in the oil and gas industry. For cross-border transactions involving parties from a broad range of jurisdictions, or disputes between an investor and a state, there is no practical alternative. It provides the opportunity for an impartial, independent determination of a dispute with an established mechanism for the enforcement of awards in most jurisdictions in the world under the auspices of the New York Arbitration Convention of 1958. Unfortunately, the dispute resolution process itself is becoming increasingly complex and uncertain, adding a further layer of difficulty to the parties finding solutions to their disputes. The time and cost associated with international arbitration now compares unfavourably with litigation (which was never a good benchmark in the first place). Extended document disclosure requests and the willingness of arbitrators to accede to them is burying the process in indiscriminate evidence. And, despite the inherent flexibility and the discretion vested in the arbitrators, first procedural orders are not always designed to meet the specific needs of the parties or the dispute, nor do they provide for an efficient and cost-effective process. This fourth perspective is a cause of concern as uncertainty over the outcome of dispute resolution process only creates additional work and delay, benefiting the international arbitration industry and not the parties it is designed to serve.

Andrew’s views, as a user, rather than a supplier, of arbitration services are important. In his foreword, he is quite critical of some of the practices that have developed in oil and gas arbitration. But as he notes, in that world (ie, the investor–state world), there is no practical alternative: arbitration is the only game in town. The parties need a neutral adjudicator, and they need the ability to enforce that award around the world. Only arbitration can provide that.

Andrew Clarke notes that the time and cost associated with international arbitration no longer compares favourably with litigation. He points to the extended disclosure requirements and the willingness of arbitrators to accede to them in burying the process in indiscriminate evidence. There is no doubt that this happens. But it gets worse: there is also unnecessary duplication of proceedings and bifurcation of issues. To some extent the energy sector is the poster child of this abuse.

Duplicate proceedings are a good example. In Spain we now face 27 arbitrations dealing with the same issue, namely whether the Spanish government was entitled to change the incentive plans to attract new investment in solar energy.  We have one decision to date.[1] It may be surprising to some that there has been so little success consolidating the claims.

This practice is not unique to Spain or the Energy Charter Treaty. In the Canadian province of Alberta, the government created power purchase agreements by which 12 generators would sell electricity to contracting parties. The agreements are virtually identical and were created by regulation and approved by the Alberta regulator. All the agreements have identical arbitration provisions.

Every one of these agreements has been subject to an arbitration under the Alberta Rules. The issue is virtually the same in each case: what is the proper treatment of inflationary indices to adjust the costs the generators entitled to recover? These arbitrations are all confidential with the result that common issues are constantly being re-litigated.This is no one’s fault, but it does point to costly inefficiency.

The other unfortunate development is the increasingly common practice to bifurcate issues. This started with preliminary objections to jurisdiction. (It is not unusual for those to last two years.) More recently we have developed a tendency to bifurcate the liability and damage phases of the arbitration. In Mobil Investments,[2] the majority delivered its award on liability in May 2012. The final award on damages was delivered in February 2015, three years later. The same thing happened in Bilcon.[3] The majority delivered its award in March 2015. The parties are still engaged in document production with respect to the damages phase.

Arbitration in the energy sector today faces a full-blown public policy conflict. Private parties are exercising their rights to attack legislation enacted by the host country to address domestic public policy concerns. The rationale for the claimants is that the change in government policy has a negative impact on their business and investment opportunities. This raises the fundamental question of whether host countries can regulate in the public interest or whether regulations and legislation must be frozen in time.

While NAFTA has been a major focus, these issues are not limited to Canada, the United States and Mexico. The German government was not amused when a private party questioned the country’s ability to phase out nuclear power[4] any more than the American government was happy when Canadian companies attempted to derail regulations designed to protect Californian drinking water.[5] Nor were Canadians happy when American companies attempted to strike down Canadian bans on fracking,[6] pesticides[7] or offshore wind development.[8]

Governments were quick to respond that private corporations were using NAFTA to curtail the right of governments to regulate in the public interest. This debate soon became worldwide, driven by leading academics and arbitrators.[9] This debate is not limited to NAFTA. The same issue arose under the Energy Charter Treaty that followed NAFTA in 1994. Today there are over 30 arbitration claims under that treaty challenging the legislation by four different European governments to change their incentive programmes for renewable energy without notice. The controversy in the NAFTA world was recently joined by another controversy driven by the economic nationalism of the new Trump administration in the United States. The issue there is not a state’s right to regulate, but a state’s right to eliminate trade deficits. It has put NAFTA under a new spotlight that includes the Chapter 11 dispute resolution mechanism.

In 2016 Candidate Trump raised the anti-NAFTA rhetoric to a new level in the form of 140-character tweets. Recently the new President signed an executive order announcing that NAFTA will be renegotiated. The order placed a broad set of issues on the table. Where that will end up is hard to say.

The real concern may be that we have inadvertently created an ‘Appeal Court of Last Resort’. In most cases, NAFTA parties first litigate in domestic courts and then appeal to NAFTA. NAFTA offers definite advantages. Damages are available under NAFTA, something that does not always exist under domestic administrative law. In Apotex[10] and Eli Lilly,[11] both companies first went to the Canadian Federal Court to contest patent rulings. When they failed,[12] they went to NAFTA. Bilcon appealed the ruling of the Nova Scotia Environmental Commission to a local court. When that failed, they went to NAFTA, where they succeeded.

Mercer International[13] went first to the BC Utility Commission.[14] When that did not work out they went to NAFTA. Mobil Investments[15] first appealed to the Newfoundland Board R&D directive to the local courts.[16] When the company lost it went to NAFTA, where it succeeded.

To make matters worse, NAFTA is a unique appeal court. Only foreign investors can bring cases. Consider the cases involving the Ontario ban on wind generation. An American company, Windstream, obtained a C$28 million judgment from a NAFTA panel[17] when Ontario cancelled the programme. Trillium Power, a Canadian company with the same complaint, was out of luck in the Ontario courts.[18] The same thing happened in SkyPower.[19] There the judge remarked: ‘While it may sometimes seem unfair when rules are changed in the middle of a game, that is the nature of the game when one is dealing with government programs.’

The next group of opponents are those that just do not like arbitrators. This group believes there should be an investment court with appeal procedures. It is an open question whether a multinational investment court will give us better decisions than arbitration panels. There is also a question of whether the Americans would buy into that concept, given the isolationist tendencies of the new administration. The Canadians seem to have bought into the concept. Courts have replaced arbitrators in the recently signed EU–Canada Trade Agreement (CETA).

Much of the analysis in NAFTA cases centres on the rights of the investor, the definitions of legitimate expectations, and indirect expropriation. But what about the state’s rights? The state must have a right to regulate; it certainly has responsibilities to regulate.

Few would object to states exercising this jurisdiction provided they act in good faith, and do not discriminate or expropriate private property without fair compensation. The NAFTA decisions in Methanex[20] and Chemtura[21] seem to support this proposition.

In Chemtura, a US manufacturer of lindane, an agricultural insecticide moderately hazardous to human health and the environment, claimed a breach of NAFTA by Canada’s prohibition of its sale. The tribunal rejected the claim, stating:

Irrespective of the existence of a contractual deprivation, the Tribunal considers in any event that the measures challenged by the Claimant constituted a valid exercise of the Respondent’s police powers. As discussed in detail in connection with Article 1105 of NAFTA, the PMRA took measures within its mandate, in a non-discriminatory manner, motivated by the increasing awareness of the dangers presented by lindane for human health and the environment. A measure adopted under such circumstances is a valid exercise of the State’s police powers and, as a result, does not constitute an expropriation.

In investor–state arbitrations, arbitrators grant deference to governments, particularly where those governments are carrying out a regulatory function where the public interest is the dominant test.

In Mesa Power[22] the tribunal pointed to the deference that NAFTA Chapter 11 tribunals usually grant to governments when it comes to assessing how they regulate and manage their affairs. The tribunal stated:

In reviewing this alleged breach, the Tribunal must bear in mind the deference which NAFTA Chapter 11 tribunals owe a state when it comes to assessing how to regulate and manage its affairs. This deference notably applies to the decision to enter into investment agreements. As noted by the S.D. Myers tribunal, ‘[w]hen interpreting and applying the “minimum standard”, a Chapter Eleven tribunal does not have an open-ended mandate to second-guess government decision-making.’  The tribunal in Bilcon, a case which the Claimant has cited with approval, also held that ‘[t]he imprudent exercise of discretion or even outright mistakes do not, as a rule, lead to a breach of the international minimum standard.’[23]

In addition to the references in SD Myers[24] and Bilcon pointed out by the Mesa Power tribunal, we can add the tribunal’s comments in Thunderbird at paragraph 127 that the state ‘has a wide discretion with respect to how it carries out such policies by regulation and administrative conduct.’[25]

Going forward

There is widespread agreement that the investor–state dispute resolution process requires serious reform. This is particularly true in the energy sector. There is a clear conflict between the interests of private corporations and the public interest mandate of states. The process as currently structured is not capable of balancing these competing interests in a meaningful and predicable fashion. The reform process will no doubt start with NAFTA, given the position of the new US administration. It will likely be a long and challenging discussion.

Notes


[1]    Charanne B.V. and Construction Investments v. Spain, SCC Arb. No.062/2012.

[2]    Mobil Investments Canada Inc and Murphy’s Oil Corp v. Canada, ICSID Case No. ARB (AF) 107/4 Award, (22 May 2012).

[3]    Bilcon of Delaware Inc v. Canada, Award on Jurisdiction and Liability, (10 March 2015), UNCITRAL.

[4]    Vattenfall v. Germany, ICSID Case No. ARB /12/12.

[5]    Methanex Corp v. United States, 44 I.L.M. 1345 (NAFTA Chap.11 Arb. Trib. 3 August 2015) (Final Award).

[6]    Lone Pine Resources Inc v. Government of Canada, Notice of Arbitration, 6 September 2013.

[7]    Dow Agro Sciences v. Canada, Settlement Agreement (UNCITRAL, 2011).

[8]    Windstream Energy LLC v. Government of Canada, PCA Case No. 2013-22, 27 September 2016.

[9]    Jose Alvarez, ‘Is Investor-State Arbitration “Public”?’, Journal of International Dispute Settlement, 2016, 7,534-576; Stephen M Schwebel, ‘The Outlook for the Continued Vitality or lack there of in Investor-State Arbitration’, Arbitration International, 2016, 32, pages 1–15.

[10]   Apotex v. United States of America, ICSID Case No. ARB (AF) 12/1(25 August 2014).

[11]   Eli Lilly and Company v. Government of Canada, Award, (UNCITRAL, 16 March 2017).

[12]   Eli Lilly Canada Inc v. Novapharm Ltd, 2011 FC 1288; Novapharm v. Eli Lilly & Co, 2010 FC 915

[13]   Mercer International Inc v. Canada, 16 May 2014 (ICSID).

[14]   Fortis BC – Application for Approval of Stepped and Stand-By Rates Decision Stage II (24 March 2015).

[15]   Mobil Investments Canada Inc and Murphy’s Oil Corp v. Canada, ICSID Case No. ARB (AF) 107/4 Award, (22 May 2012).

[16]   Hibernia Management and Development Co v. Canada Newfoundland Offshore Petroleum Board, [2007] NJ No. 168; Hibernia Management and Development Co v. Canada Newfoundland Offshore Petroleum Board, [2008] NJ No. 310.

[17]   Windstream Energy v. Canada, PCA Case No. 2013-22, 27 September 2016.

[18]   2013 ONCA 683, 117, OR (3d) 721.

[19]   SkyPower v. Ministry of Energy, [2012] OJ No. 4458 at paragraph 84.

[20]   Methanex Corp v. United States, Decision on Amici Curiae 15 January 2001; UPS v. Canada, Decision on Amici Curiae, 17 October 2001.

[21]   Chemtura Corporation v. Canada, Award, (UNCITRAL, 2 August 2010).

[22]   Mesa Power Group LLC v. Government of Canada, PCA Case No. 2012-17, 24 March, 2016.

[23]   Id. at paragraph 553 (footnote omitted).

[24]   S.D. Myers v. Canada (NAFTA/UNCITRAL), First Partial Award, 13 November 2000.

[25]   International Thunderbird Gaming Corp v. United Mexican States, at paragraph 127, Award, (UNCITRAL 26 January 2006).

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