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Price review arbitrations are not all about economics – everyone has to remember the law!

Recently I attended the 3rd Annual Global Arbitration Review (GAR) Live Energy Disputes conference in London.  A stimulating day of discussion about developments in the international energy business closed with a vigorous debate on the following motion: “This house believes that there’s no law in gas pricing arbitration”.

Those supporting the motion focused on the complex commercial and economic exercise arbitrators in a gas pricing dispute must tackle.  In essence, they contended the arbitrators, by reference to current market conditions, try to update the parties’ commercial deal by copying the economic exercise those parties undertook when they agreed their long-term SPA.  In short, arbitrators decide what the parties should have agreed given the current facts.

Those arguing against the motion forcefully reminded the conference that gas and LNG price reviews take place within the legal structure set out in the SPA.  So, interpretation of the scope of the relevant price review clause remains at the heart of the dispute.  Further, any award the arbitrators make in the first price review under the SPA will inevitably impact later reviews under that contract, i.e. applying the law of issue estoppel is often central to pricing disputes.  So, a price review is not just a commercial and economic exercise.

I have some sympathy for both sides’ opinions.  However, while respecting the central role economic arguments play, it is going too far to say there is no law in gas pricing arbitration.

My experience of gas pricing disputes is that most of both sides’ cases focuses on the economic evidence with the independent experts take opposing views on several topics. For example, the state of the relevant market(s) at particular times, what are the competing fuels and, critically, the most apt data and methods for calculating a new price.  As a result the economic issues can dominate the arbitration.  One point of view is that price reviews are intended simply to re-run the economics underlying the parties’ original deal to update the price to reflect current market conditions.

However, most of the audience at the GAR conference did not accept this limited view of gas pricing arbitrations.  Although economic arguments may dictate the arbitration and final hearing, the parties must always present those arguments through the prism of the law.  All the price review arbitrations I have worked on raised difficult questions about interpreting the price review clause.  In my most recent price review, submissions expressly dealt with applying the English Supreme Court’s recent decision in Arnold v Britton to the clause.  I accept the economic evidence may colour how a party chooses to advance its case on the meaning of the price review clause.  Nonetheless, the experts must present their evidence given the instructions they receive upon the exercise the price review clause requires.  Further, ultimately, the tribunal must apply their understanding of the expert evidence to the objective criteria in the clause to decide whether (and, if so, how) the price should change.  Deciding how the price clause is to be interpreted and whether, in the light of two different experts’ opinions, the test it sets is met, are inherently legal exercises.  That is why parties send price reviews to arbitration, not expert determination.  It is also why parties choose lawyers as arbitrators rather than economists, although hopefully lawyers who can understand complex economic evidence.

Finally, it was notable that the moot arbitrators at the GAR conference mentioned issue estoppel as a key reason they could not accept the motion.  Those of us who have worked on second (and later) price reviews will know how important this area of law can be.  The award on a first price review will reverberate through the remaining term of the SPA.  In particular, the tribunal’s interpretation of the price review clause will often bind future tribunals considering price reviews under that SPA.  The second edition of GAR’s Guide to Energy Arbitrations recognises the central role issue estoppel plays in price reviews.  It includes a new chapter that Liz Tout and I have written tackling this subject.  So, perhaps next year, the motion considered at the GAR conference should be: “This house believes contractual interpretation and issue estoppel lie at the heart of disputes under long-term energy contracts”.

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Price review arbitrations are not all about economics – everyone has to remember the law!

This is not another article about Macondo: no, I want to know why people even bother with Gross Negligence in Joint Operating Agreements?

Judge Barbier decided that BP was grossly negligent in relation to the blowout, explosion and fire abroad the Deepwater Horizon in April 2010.  But Transocean and Halliburton were merely negligent.  Some might say that is a political decision.  After all, President Obama called the result of the litigation within 24 hours after the explosion happened.  However, none of that particularly worries me.  What I really want to know is why do people even bother with Gross Negligence in Joint Operating Agreements for offshore oil and gas exploration and production?

The size of the necessary investments and risks involved in international energy business often result in companies (even the largest multinationals) forming consortia to share risks (and, hopefully, rewards).  These consortia commonly use Joint Operating Agreements (JOAs) to regulate the members’ respective rights and obligations.  One member, the operator, takes responsibility for achieving the objects of the consortium, including concluding contracts with service providers and carrying out all steps necessary to meet its responsibilities.  Despite the burden of acting as the operator, planning, procuring, running and undertaking operations and incurring substantial liabilities in doing so, the member fulfilling that role does not receive any financial reward for doing so.  Its only reward, as with the non-operators, is through holding a participating interest in the venture.  Therefore, as operators gain nothing from their burdensome role JOAs typically ensure that operators do not bear any financial responsibility beyond their participating interest either.  Otherwise, why would anybody ever agree to be the operator?  That is the question that lies at the heart of JOAs.  And if there are no operators, then there are no projects and no rewards.  To persuade me to be the operator, you non-operators have to agree that I have no liability beyond my share.

However, if I am a non-operator, I may feel a little uncomfortable giving the operator a blank cheque.  What if it really makes a mess of things?  Why shouldn’t it pick up the entire cost of a complete disaster?  The solution more distinguished lawyers than me have devised is definitions of Gross Negligence and Senior Supervisory Personnel to provide the possibility that operators might be wholly liable for a disaster.  But, at the same time, they draft those definitions narrowly to make the possibility so remote that operators are still willing to take on the role.  The result is a playground for litigation lawyers.

So where does that leave the courts?  What gross negligence means in a civil liability context is a difficult question English law has struggled with.  The traditional view is:

“Epithets applied to negligence, so far as the common law is concerned, are really meaningless. Negligence is well known and well defined. A man is either guilty of negligence or he is not guilty of negligence. Gross negligence is not known to the English common law so far as civil proceedings are concerned.” Pentecost v. London District Auditor [1951] 2 KB 759

In more recent times, applying the usual principles of contractual interpretation and “borrowing” from our American friends, the English courts have tried to give some meaning to the word “gross”.  So, now, English law thinks:

‘Gross negligence’ is clearly intended to represent something more fundamental than failure to exercise proper skill and/or care constituting negligence. But, as a matter of ordinary language and general impression, the concept of gross negligence seems to me capable of embracing not only conduct undertaken with actual appreciation of the risks involved, but also serious disregard of or indifference to an obvious risk …” Red Sea Tankers Ltd v. Papchristidis and others [1997] 2 Lloyd’s Rep 547

In a corporate context, this interpretation raises the problem of who can form the necessary intention or disregard/ indifference to fix the company with liability for gross negligence?  Hence the use of a definition of “Senior Supervisory Personnel”.  The aim is to make sure that “hands” at the coal-face of operations, pushing buttons and pulling levers, do not qualify for gross negligence.  Only “minds” back in offices making senior management decisions about operations qualify.  That, of course, leaves an interesting intermediate ground between the two: what about people who analyse data and tell people which buttons to push and levers to pull?  I would say that they are closer to the coal-face than the senior management, although Judge Barbier disagreed.

Which bring us back to the problem.  The cases that may reach the courts will be difficult from a merits perspective, which risks judges making bad law.

So I find myself asking why bother with all the problems gross negligence creates?  Perhaps the offshore energy business (especially the big players) should take a more pragmatic and realistic approach?  Everyone knows the risks involved in that business and that accidents happen.  As “easy” oil vanishes and projects become evermore challenging technologically, those risks are becoming more acute.  Just ask BP.  I think this means the question “why would anybody ever agree to be the operator?” should now trump the worries of nervous non-operators.  They should trust their colleagues who are brave enough to act as operator.  And they should expect their colleagues to trust them when they are brave enough to act as operator themselves.  If there is no trust, why are we in a joint venture anyway?  And non-operators can always keep a strategic eye on the operator in the operating committee meetings and sack him if they do not like what he is doing.  No operator wants Macondo to happen but, unfortunately, another incident inevitably will occur one day.  So, I propose we forget about arguing what amounts to Gross Negligence or whether a data analyst is important enough to qualify as Senior Supervisory Personnel.  Let’s just limit operators’ liability to their participating interest share.  Then operators and everyone else can focus on what is really important: getting the oil out of the ground.

This is not another article about Macondo: no, I want to know why people even bother with Gross Negligence in Joint Operating Agreements?