Is arbitration possible under deep water block licensing contracts?

Introduction Clause 23 – administrative and contractual termination Clause 26 – dispute resolution and applicable law Comment

Introduction

In December 2015 the Ministry of Energy published the bidding guidelines for the fourth phase of the first round of tendering for the exploration and extraction of hydrocarbons in deep water blocks, which changed the model contract used in the third phase from a production sharing contract to a licensing contract.

The auction was divided into two zones:

• Cinturon Plegado Perdido, which was divided into four blocks; and
• Cuenca Salina, which was divided into six blocks.

In December 2016 the results of the bidding process were officially published and eight of the 10 auctioned blocks were awarded as follows.

Cinturon Plegado Perdido

Cuenca Salina

The awarded companies and the National Hydrocarbons Commission (CNH) have 90 days from the official publication of the results to sign the relevant contracts. It is thus timely to analyse whether investors can settle disputes regarding termination of a contract for administrative reasons by way of arbitration.

The model licensing contract is divided into 35 clauses. This update focuses on Clauses 23 and 26 in relation to an administrative termination.

Clause 23 – administrative and contractual termination

Clause 23.1 of the model licensing contract establishes that the administrative reasons for which a licensing contract can be terminated are the same as those established in Article 20 of the Hydrocarbons Law.

If there is an indication or assumption that the investor is not complying with its obligations, which constitutes administrative grounds to terminate the contract, the CNH will notify the investor of this and start an official investigation into whether there is a feasible reason to terminate the contract. The investigation must take at least 30 days and no longer than two years.

Once the investigation has been concluded, the CNH must deliver formal written notification of the results to the investor. The investor will then have 30 days to present its arguments, after which the CNH will have 90 days to issue its final decision.

Clause 26 – dispute resolution and applicable law

The dispute resolution and applicable law clause in the model licensing contract is surprisingly unclear. It states that the obligations imposed by and compliance with the contract are bound by and will be interpreted in accordance with Mexican legislation. However, it also states, rather narrowly, that investors will be entitled to all of the existing rights established in any international treaty that applies to the parties.

The following dispute resolution options are available:

• Clause 26.2 – conciliation:
  • Any kind of dispute, with the exception of one relating to the termination of a contract for administrative reasons, can be resolved under this scheme.
• Clause 26.4 – claims before local federal tribunals:
  • Claims relating to the termination of a contract for administrative reasons can be resolved only before a local federal tribunal.
• Clause 26.5 – arbitration:
  • Any kind of dispute, with the exception of one relating to the termination of a contract for administrative reasons, can be brought before the International Court of Justice.

Thus, if the CNH terminates a contract for administrative reasons, the investor cannot resolve the dispute by arbitration. Instead, it is bound by the contract to present the claim to a domestic tribunal.

In light of the above, there is a possibility that a conflict between international and domestic law could arise, as most international treaties to which Mexico is a party stipulate that investors have the right to settle an investment dispute by way of arbitration. This is because arbitration:

• treats parties equally in accordance with the principle of international reciprocity; and
• ensures due process before an impartial tribunal, with the aim of providing the fairness and predictability that investors look for before entering the market.

In this context, denying investors access to arbitration in specific circumstances is arguably a violation of the main investment protection provisions provided for under international law.

The literature on this subject suggests that in order for a claim to be settled by way of international investment arbitration, "the claimant must satisfy the tribunal that its claim falls within the substantive protection of the Treaty, by constituting either a breach of one of the protected investors' rights… or an expropriation of property".

This can be interpreted to mean that a claimant's mere assertion of the existence of a violation of an applicable international treaty is insufficient, as the tribunal must also determine whether it has jurisdiction to hear the claim. This was argued by the International Court of Justice in a case concerning oil platforms, in which it stated that it "must ascertain whether the violations of the Treaty… pleaded by Iran do or do not fall within the provisions of the Treaty and whether, as a consequence, the dispute is one which the Court has jurisdiction ratione materiae to entertain".

It is important to identify which treaty provision has been violated, in order to determine the appropriate approach for presenting the claim before an international tribunal in a manner that will satisfy its jurisdiction criteria. For example, in Azinian the claimants argued that Articles 1105 (minimum standard of treatment) and 1110 (expropriation and compensation) of the North American Free Trade Agreement had been violated because the local government had withdrawn the claimant's waste management licence on the basis of irregularities.(1) However, this was not the best approach. The main issue was that the licence withdrawal had been legal and ratified by the local tribunals and, as such, the matter was not one of international jurisdiction. In order to succeed with the international claim, the most feasible option would have been to challenge the local tribunal's decision. The licence withdrawal could thus have been presented as an international conflict, most likely by arguing that there was a lack of due process in the context of administrative proceedings, as was the case in TECO.(2)

In theory, domestic and international investment laws do not – at a certain level – conflict, as the latter can protect investors' rights when an international treaty is clearly violated by the host state. In Mexico, international treaties have more weight than the Constitution, but less than federal legislation.

Comment

If the CNH terminates a licensing contract on the basis of administrative matters, the investor could follow the domestic path before the host state's tribunals and, if unsatisfied with the final decision, present its claim before an international tribunal. Alternatively, if the investor considers that arbitration is prohibited under Mexican law, it could go directly to an international tribunal and argue that there has been a denial of justice and a breach of the fair and equitable treatment provision of an applicable international treaty. However, this latter option must be well considered, and the party should analyse the best approach to present a claim before an international tribunal in order to satisfy its jurisdiction criteria.

For further information on this topic please contact Mauricio Lievana at Ibáñez Parkman y Asociados SC by telephone (+52 55 5250 5912) or email ([email protected]). The Ibáñez Parkman y Asociados SC website can be accessed at www.i-parkman.com.

Endnotes

(1) Azinian v United Mexican States, ICSID Case ARB (AF)/97/2.

(2) TECO Guatemala Holdings, LLC v Republic of Guatemala, ICSID Case ARB/10/23, December 19 2013.

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