Economic stability is one of the most important issues for a sponsor to consider when investing in a project in a foreign country, especially when dealing with the governments of developing nations in industries that are politically sensitive such as the export of energy and other natural resources. The success of such an energy project will depend upon the economic basis for the investment decision continuing without significant deterioration into the future. Sponsors are well advised to insist on a robust economic stability clause in an investment contract with a host country government. A project agreement, production sharing contract, exploration and production agreement, license or concession are common types of Host Country Agreement (“HCA”).
There are many actions that a host country government can take (or fail to take) that affect adversely the economics of an energy project. A government can impose new taxes; enact burdensome regulations; withhold, delay, cancel, or fail to renew necessary permits; expropriate assets or ownership of a project; or declare an HCA, or portions of it, invalid or unenforceable. Such government actions or failures to act can adversely affect all entities involved in a project -- not just the sponsors, but also the contractors, shareholders, suppliers, offtakers, financiers, and their affiliates involved in the project (these entities other than the sponsors, the “beneficiaries”). A host government might take these actions for a variety of reasons. The government might determine after the successful commencement of a project that the commercial terms of the HCA (the production or profit split, for instance) are unfair and may take action to cause more revenues to flow to the host country or pressure the sponsor to revisit the terms.
When negotiating an HCA, a sponsor should take care to provide for the economic stability of a project. To the extent that the strength of the sponsor’s bargaining power allows, the sponsor should aim for a detailed and broad economic stability clause that protects the sponsor and the beneficiaries. While some governments will refuse to entertain a provision with such scope, this article discusses some of the aspects of a sponsor-friendly economic stability cause.
Notice of change in law and covenant to exempt
The stability clause should contain a covenant by the government to give the sponsor ample written notice of any proposed change in law that may affect the project’s economics. Further, the government should covenant to take promptly all actions necessary to exempt the sponsor and the beneficiaries from the application of such change in law. “Change in Law” should be defined broadly to include: (i) any change in interpretation or enforcement of existing law; (ii) the adoption, promulgation or modification of any new laws (including any tax, customs duty, royalty, foreign exchange, or insurance law); and (iii) the imposition of new conditions to the issuance or renewal of any permit that did not exist at the time of the execution of the HCA.
Host country government indemnity
The stability clause should contain an indemnity under which the government agrees to indemnify the sponsor and the beneficiaries from any losses that incur as a result of any Change in Law, expropriation, political event, or the breach or invalidity of the HCA. The purpose of the government indemnity is to allow the sponsor and the beneficiaries to be compensated for loss of commercial and/or fiscal benefits they would have received had such event not occurred.
As with the definition of “Change in Law,” the stability clause should define each such event broadly. “Expropriation” should encompass: (i) the confiscation, compulsory acquisition, or nationalization of the project, any project asset, land, or any right of a project company; and (ii) the procurement by the government of control of any project company or its management. The stability clause should state specifically the minimum threshold amount of government ownership that constitutes “control” for purposes of the definition of Expropriation.
A “political event” should be defined to include (among other things as circumstances may dictate): (i) war, terrorism, blockade, revolution or civil war, strikes, and other labor actions; (ii) the failure of the government to issue or renew a permit; and (iii) if a National Oil Company (NOC) is a co-sponsor of the project, the bankruptcy of the NOC.
Remedy and Valuation
The economic stability clause should provide a remedy that makes the sponsor whole for any adverse change in the economic environment. One remedy is to provide the sponsor the right to transfer ownership of the project to the government if any action or inaction of the government or any of the events requiring indemnification prevents or impedes either: (i) the development, financing, ownership, construction, or operation of the project; (ii) the exercise of control over project assets or the conduct of project business; (iii) any third party from performing its obligations under project contracts; (iv) the sponsor from exercising or benefitting from its rights; or (v) effective control over project revenues. Upon such transfer of ownership of the project, the government shall pay to the sponsor an amount equal to the value of the project as determined pursuant to a formula set forth in the HCA. Such valuation should take into account debt incurred with respect to the project, equity invested, and the present value of a fair return on equity over the expected life of the project.
Having a host country government agree in the HCA to a valuation does not guarantee that it will pay, but such agreement makes a strong basis for arbitration if it does not.