The Guide to Infrastructure and Energy Investment

Balance of Power Between Local and International Partners in Infrastructure and Energy Projects in Latin America

Latin America has become a primary target for investment in energy and infrastructure projects. Latin America contains approximately 10 per cent of the world’s proven oil reserves and approximately 4 per cent of the world’s proven gas reserves.[1] Venezuela, Mexico, Brazil, Colombia, Argentina and Ecuador are among the nations in Latin America with the largest oil reserves, while Venezuela, Brazil, Bolivia, Peru and Argentina are among those with the largest gas reserves.[2] These considerable oil and gas reserves allow Latin America to be a net exporter of energy products, and also make Latin America an attractive target for foreign investment, particularly from China and India.[3] Moreover, Latin America’s growing population and demand for electricity makes the region attractive for foreign investment.[4]

Recently, Latin America has become a hotbed for renewable energy investment, as the renewable energy market in Europe has experienced significant decline.[5] For example, Chile, Brazil and Mexico have climbed into the top 10 on Ernst & Young’s Renewable Energy Attractiveness Index, which measures market attractiveness in the renewable energy sector.[6] Chile’s growth in renewable energy is due, in part, to the government’s plan to decrease the country’s reliance on traditional sources of energy and have a larger per centage of the country’s energy supplied by renewables. Mexico has also risen on the index, partly due to the country’s energy reform policy that has allowed the private sector to enter the country’s energy market. The development of the renewable energy market in Latin America has led to a significant increase in foreign investment in energy and infrastructure projects in the region. In fact, Mexico recently held its first energy auction, which attracted an estimated US$2.5 billion in investment.[7]

The development of any large, complex energy or infrastructure project requires the negotiation and execution of complex agreements between multiple parties. States will typically need to enter into concession agreements with investors and developers. Developers will typically want to enter into lending agreements with financing institutions. Developers will also need to enter into construction agreements with contractors and subcontractors for the construction of the project. Contractors and subcontractors will then need to enter into supply agreements with suppliers for the provision of the equipment and parts necessary to build the project.

In energy projects, developers will need to enter into power purchase agreements (PPAs) with offtakers and fuel supply agreements with fuel suppliers (or, in the case of a tolling arrangement, the same counterparty will take the power and supply the fuel). Without a PPA or tolling agreement, financing will be more difficult to obtain. Further, the developer will need to enter into an operating and maintenance agreement with the party that will actually operate the project and potentially numerous other agreements relating to the project.

One of the most important contract provisions the parties will negotiate in each project document is the dispute resolution clause. This clause defines the parties’ rights in the event that a dispute arises, and establishes the legal framework for the resolution of those disputes. As with the other terms of the agreement, each of the players involved in the development of the project will seek to shape the dispute resolution clause in a way that advances their own interests.

As the Latin American energy and infrastructure markets continue to be the target of significant investment, it is important to understand the interaction between each of the parties involved and the bargaining power that each possesses. This article will examine the key players involved in energy and infrastructure projects, the key agreements that are negotiated and the often conflicting interests and uneven bargaining power of each of these parties, particularly relating to the negotiation of dispute resolution clauses. Finally, this article will examine how the dispute resolution provision may be used to establish a level playing field for each of the parties in relation to the resolution of disputes.

Key players and key agreements

As discussed above, the development of any large, complex energy or infrastructure project requires the interaction of a number of key players. The main parties advancing the projects are primarily the state, the investors and developers, and the lenders.

Undoubtedly, the state is a central player in any project. The state controls the legal and regulatory framework within which the project must be carried out. In Latin America, most states own the subsoil resources found within their respective territories and can control the manner in which those resources are used. Accordingly, most states must grant foreign investors permission to use and exploit natural resources.

States often grant investors access to the state’s natural resources pursuant to a concession agreement. A concession agreement grants an investor the legal right to explore and exploit a state’s natural resources for a specified period of time. Without a concession agreement, an investor does not have the legal right to develop an energy project in the country. It is important to recognise that just as governments can grant foreign investors the right to use and develop natural resources, they may attempt to revoke those rights at a later date.

The investor will need to enter in an agreement with a contractor to develop the project. The most common form of contract executed with contractors is an engineering, procurement and construction (EPC) contract. In an EPC contract, a contactor promises to deliver a fully completed and operational project by a fixed date. An EPC contract is attractive to investors because one person – the contractor – is responsible for the construction of the project. The EPC contract will detail, among other things, the performance metrics for the project, when the project must be completed, the contract price and the circumstances under which a contractor may seek extensions of time or additional compensation. The EPC contract will also define the liability of the contractor for an underperforming or late project, and the potential liability of the contractor to other project partners.

Another key player in the case of an energy project is the energy offtaker. When projects are developed at the request of the sovereign, the energy offtaker may be a state-owned company or some other government instrumentality authorised to purchase and resell power. To this end, the government and the investor may enter into a mid- or long-term PPA, in which the government agrees to purchase a certain amount of electricity to be generated by the project. By executing a PPA, an investor can guarantee that the project will have steady cash flow.

Lenders and financing institutions are also a key group of players. Without financing to fund the exploration and exploitation of natural resources, and to build the infrastructure for the generation and selling of power, there can be no project. The most common form of financing for large energy projects is known as project financing, where the financing is secured by the assets of the project itself. Project financing may be provided by commercial lenders, but also by governments through export credit agencies, or multinational organisations such as the World Bank, the Inter-American Development Bank and the Central American Bank for Economic Integration. Developers with EPC contracts and PPAs may have an easier time obtaining financing if the contract counterparties are known players in the market and financially sound.

Lenders will typically require investors, owners and contractors to accept certain terms in their agreements in order to ensure they are repaid once the project is completed. For example, lenders may insist that contractors complete the work within a specified period of time and may limit the ability of the contractor to request extensions of time to ensure that the project begins generating revenue as quickly as possible. Lenders may also require that the project achieve certain performance guarantees, again to ensure that the project is profitable and that the investor is able to repay the loan.

All of the project documents will need to provide a consistent package of rights and obligations for the developer. Construction and development milestones should be consistent and the completion dates in the EPC contract should enable the developer to meet its payment obligations under the financing agreement. Also, force majeure clauses in the EPC contract and the PPA should match as much as possible, and the developer’s rights under the EPC contract and PPA should facilitate the developer’s compliance with its obligations under the financing agreement.

As discussed, the development of an energy or infrastructure project involves numerous players who often have diverging interests. Governments are interested in ensuring that foreign investors do not abuse the local legal and regulatory framework. Lenders want to ensure that they are repaid as quickly as possible. Developers want to finish the project as quickly and efficiently as possible, and also want to be protected against wrongful regulatory actions during operations, so that they can recover their development costs and make a reasonable return on their investment. These conflicting interests can collide as the parties negotiate a contract’s dispute resolution provision.

The importance of the dispute resolution clause

The dispute resolution clause is a critical component of any agreement. This clause defines the parties’ rights in the event that a dispute arises concerning the contract, and typically places limits on what legal actions a party may take.

The clause will also establish whether the parties are required to file legal actions in the local courts or whether a dispute may be resolved through a form of alternative dispute resolution, such as arbitration. Resolving disputes in the local courts is not a preferred option for developers, as the local courts may be unfamiliar with sophisticated commercial arrangements or, perhaps more troubling, partial to the interests of the state or local parties. Therefore, arbitration has become the predominant method for dispute resolution in many energy and infrastructure contracts.

If the parties choose to resolve their disputes through arbitration, the dispute resolution clause should define the scope of the clause itself. Often parties will opt for a dispute resolution clause that will require arbitration not only for disputes based on the contract at issue, but for any and all disputes arising out of the contract, whether based on the contract itself, a statute, a tort or some other basis. Otherwise, there is a risk that arbitration will be limited solely to contract disputes, whereas all other disputes will be subject to resolution by the local courts.

The dispute resolution clause will likely specify whether an arbitral institution will administer the dispute, such as the International Chamber of Commerce, the London Court of International Arbitration or the Singapore International Arbitration Centre. The centre administering the dispute will apply the procedural rules governing the selection of arbitrators, the issuance of the award and other administrative matters.

The dispute resolution clause will also determine the governing law. The applicable law will determine how the provisions of the contract are interpreted and will define the parties’ substantive legal rights. When a contract is entered into with a sovereign involving a project that will be developed and operated within the sovereign’s territory, the sovereign will almost certainly insist that its law should govern the contract. There are occasions, however, when a sovereign will agree to resolve disputes under the law of a different jurisdiction. Whatever law is chosen, the investor should be aware of whether there are any principles of law that may trump aspects of the parties’ bargain.

Perhaps more important than the governing law, the dispute resolution clause will designate the seat of the arbitration. The seat of arbitration is often a heavily negotiated provision, given that courts of the seat are in an ideal position to enforce the agreement to arbitrate, as well as the arbitral award. In addition, the arbitral award may only be vacated or annulled in the courts of the seat of arbitration. As far as an investor is concerned, it will want to choose a seat that is pro-arbitration – one that will let the arbitration process run its course without judicial (or other governmental) interference, and that will impartially consider requests to enforce or vacate the arbitral award, without bias in favour of the state.

In 2011, for example, Mexico’s Eleventh Collegiate Court annulled an ICC award issued by a three-member panel of arbitrators in Mexico City (the seat of the arbitration) worth approximately US$300 million in favour of Corporación Mexicana de Mantenimiento Integral, S De RL de CV.[8] The Mexican court held that matters brought against state agencies, like the respondent Pemex-Exploración y Producción, a Mexican state-owned oil and gas company, should be filed exclusively with Mexico’s Tax and Administrative Court, and not resolved through arbitration.[9]

The clause may also include a number of other aspects governing the arbitration process, including, for example: the number of arbitrators that will resolve the dispute, the background and nationalities of the arbitrators, the language of the arbitration and the deadline to issue an arbitral award.

In addition, a dispute resolution clause may limit the remedies and damages that a party may obtain. For example, a contract may limit a contractor’s liability to a fraction of the total contract price. The contract may also preclude a party from seeking consequential or punitive damages or may prohibit the arbitrators from awarding injunctive or other equitable relief.

Finally, if one of the parties to the agreement is a state or an instrumentality of a state, it is advisable that the dispute resolution provision include an express waiver of sovereign immunity covering the agreement to arbitrate and all of its terms, as well as the recognition and enforcement of arbitral awards against sovereign assets.

The different components of a dispute resolution clause can have a significant impact on each party’s legal rights and remedies. It is no surprise that such clauses are heavily negotiated, with each player exercising its influence in an attempt to win the most favourable terms.

Balance of power in the negotiation of dispute resolution clauses

Each of the key players discussed above exercises its bargaining power to shape the dispute resolution clause in a way that best suits its interests. States, arguably, have the greatest power to exert. States control the legal and regulatory framework of the country in which investors seek to develop their projects and can set the rules by which foreign investors have to abide if they wish to do business in the country. Moreover, as discussed above, most Latin American states own the natural resources found within their territories, meaning that foreign investors need the state’s permission to explore, extract and exploit any resources.[10]

Typically, states prefer to have foreign investors submit disputes to the jurisdiction of the local courts and require the application of local law. States fully understand the local judicial system and typically have stronger relationships with the relevant players, and consequently can exert great influence over the process. It is not surprising that, in light of these advantages, a state may be reluctant to submit itself to the jurisdiction of an international tribunal, which is impartial and outside of the state’s influence and control.

Recently, a number of Latin American states have enacted constitutional amendments and other laws limiting the remedies available to a foreign investor seeking to contract with the state. For example, in 2009, Bolivia amended its Constitution to require foreign investors to submit to the jurisdiction of Bolivian courts and apply Bolivian law if they wish to do business in the country. In particular, Bolivia enacted Article 320 of its Constitution, which provides that:

[e]very foreign investment shall submit to Bolivian jurisdiction, laws and authorities, and no one may cite an exceptional situation, nor appeal to diplomatic claims to obtain a more favourable treatment.[11]

Moreover, Article 366, which applies to foreign investors seeking to invest in the production of hydrocarbons, requires all foreign investors to submit to the jurisdiction and laws of Bolivia and prohibits foreign investors from resorting to international arbitration to enforce rights. Article 366 states:

Every foreign enterprise that carries out activities in the chain of production of hydrocarbons in name and representation of the state shall submit to the sovereignty of the state, and to the laws and authority of the state. No foreign court case or foreign jurisdiction shall be recognised, and they may not invoke any exceptional situation for international arbitration, nor appeal to diplomatic claims.[12]

Ecuador also prohibits parties contracting with the state from engaging in international arbitrations altogether, requiring parties to submit to the jurisdiction of the local courts. Article 422 of the 2008 Ecuadorian Constitution states that:

[t]reaties or international instruments where the Ecuadorian state yields its sovereign jurisdiction to international arbitration entities in disputes involving contracts or trade between the state and natural persons or legal entities cannot be entered into.[13]

Therefore, Ecuador allows disputes between the state and citizens of Latin America to be resolved by regional arbitration entities.

A less extreme example is Mexico’s recent law on the dispute resolution mechanisms that may be used by foreign investors in the production of hydrocarbons. Article 21 of the law provides that:

controversies related to the Exploration and Extraction Contracts ... may be resolved through alternative mechanisms, including arbitration agreements in accordance with the provisions of [Mexico’s Commercial Code], international treaties on arbitration, and dispute resolution to which Mexico is a party.[14]

The law, however, specifies that any arbitration must be governed by ‘Federal Mexican Laws’, the arbitration must be ‘conducted in Spanish’, and the award ‘shall be in strict law and shall be binding on both parties’.[15] Unlike Bolivia’s law, Mexico’s hydrocarbons law allows parties to resolve disputes through arbitration, but requires the parties to apply Mexican law and conduct the arbitration in Spanish. Thus, while an investor will not be subjected to home-court advantage in the Mexican courts, it may be less familiar with Mexican law and practitioners of that law than its Mexican counterpart.

In addition to passing legislation, states may try to restrict access to international arbitration by including express waivers of the right to arbitrate in the state’s model contracts with foreign investors.[16] A state may require that a foreign investor expressly waive the right to resort to treaty arbitration when the dispute arises under a contract that includes an arbitration provision. The Colombian model concession agreement originally contained a provision stating:

The parties agree not to resort to investment arbitration contemplated in any bilateral investment treaty or other international treaty that may contain the aforementioned protection and that may come to be applicable, when a controversy has arisen between the parties relating to the initiation, execution or termination of the present contract, in which case the parties should resort to the dispute resolution mechanisms referred to in the present contract to resolve such controversies.[17]

Thus, under the Colombian model concession agreement, the foreign investor must waive the right to seek redress pursuant to an international treaty and may only pursue the remedies expressly stated in the contract, which may include commercial arbitration pursuant to the contract’s terms.

Venezuela’s model contract relating to the exploration and exploitation of hydrocarbons, however, prohibits resort to any alternative dispute resolution mechanism and requires the parties to submit to the jurisdiction of Venezuelan courts.[18] The model contract states that:

disputes and controversies arising out of a breach of the conditions, terms, procedures and actions that constitute the object of the contract or derive from it, shall be resolved in accordance with the legislation of the Bolivarian Republic of Venezuela and before its jurisdictional organs.[19]

In addition to states, lenders also exercise significant influence in shaping dispute resolution clauses, including clauses in the arbitration agreement between the investor and a third party. As discussed above, investors cannot develop large, complex infrastructure and energy projects without financing. Knowing this, lenders often seek to include terms favouring their interests in dispute clauses. Lenders, for example, tend to prefer to resolve disputes in jurisdictions with a predictable, well-established law regarding lender rights, such as New York. Indeed, the lender’s primary concern is getting repaid; resolving a dispute in a forum that has the capacity to quickly and effectively make that happen is a lender’s central interest.

As new lending sources become available to investors, lenders may have less ability to insist on terms in dispute resolution clauses that are favourable to their interests. When the energy sector in Latin America was in its early stages, private banks were reluctant to provide financing given the significant risk involved in developing large energy projects in an unproven sector. Lending was provided primarily by the World Bank, the Inter-American Development Bank and the Central American Bank for Economic Integration. As the energy sector in Latin America matured, and energy projects proved successful, private banks began lending money and competing with these institutions.[20]

Finally, the ability of foreign investors and developers to shape dispute resolution clauses varies depending on forces largely outside of their control. As noted, most states in Latin America own the natural resources within their territory and some of these states require investors to submit to local law and the local court system. Most investors, however, do not prefer to submit to local jurisdictions, which they may perceive as biased in favour of the state. Also, foreign investors likely lack familiarity with local laws and the local judicial process. Even if a state accepts arbitration, it may later attempt to litigate disputes in its local courts, so protection against that should be built into the dispute resolution clause, if possible (such as, for example, by including an express bar against circumvention, which may assist the investor in obtaining an anti-suit injunction). Investors will likely be able to exercise greater leverage when states are experiencing an economic downturn and are in need of significant foreign capital to spur economic development. Energy demand may also affect an investor’s bargaining power, with foreign investors having greater leverage when demand is high but supply is low.

Achieving equilibrium among differing interests

While each of the key players will try to shape dispute resolution clauses to meet their interests, these clauses can also be drafted to ensure that no one party has an unfair advantage. For example, the investor may insist that any dispute concerning that contract be seated outside of the host state. The parties can also agree on the application of a well-known neutral law, rather than local law. Many parties agree to have disputes resolved under New York law, as it offers a clear legal framework for the resolution of international disputes, has well-developed and predictable commercial law, and neutral courts with extensive experience in complex commercial disputes.

The parties can achieve greater neutrality by agreeing to have the dispute heard by three arbitrators, in which each party can select one of the arbitrators. The parties can require the arbitrators to have expertise in resolving commercial disputes and can require the arbitrators to be nationals of states other than those involved in the dispute, minimising bias and influence.

Conclusion

The balance of power between the key players involved in the development of large, complex energy and infrastructure projects is a constantly shifting paradigm, especially with respect to the negotiation of the terms of a contract’s dispute resolution provision. While states tend to have great influence, given their control of, and access to, natural resources and the legal and regulatory framework under which the investment is made, lenders and investors may also exert significant influence, especially when investment in the relevant sector is needed to meet demand. The dispute resolution clause may be drafted to ensure a balanced and neutral forum to resolve disputes.

Notes

  1. See Georg Caspary, ‘The Energy Sector in Latin America.’ Deutsche Bank Research, Latin America (7 September 2007), available at www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000215273.pdf.
  2. Idem.
  3. Idem.
  4. See ‘Latin American Power: Opportunities Amid EM Market Turmoil.’ (29 September 2015), available at http://www.bmiresearch.com/news-and-views/latin-america-power-opportunities-amid-em-market-turmoil.
  5. See Sam Pothecary, ‘Latin America Becomes More Attractive for Renewable Energy Investment, as Europe Suffers the Reverse Trend.’ PV Magazine (10 May 2016), available at www.pv-magazine.com/news/details/beitrag/latin-america-becomes-more-attractive-for-renewable-energy-investment--as-europe-suffers-the-reverse-trend_100024503/#axzz48XK7kuAV.
  6. See 2016 Ernst & Young Renewable Energy Attractiveness Index, available at www.ey.com/Publication/vwLUAssets/EY-RECAI-47-May-2016/$FILE/EY-RECAI-47-May-2016.pdf.
  7. Idem.
  8. See Corporación Mexicana De Mantenimiento Integral, S De RL De CV v. Pemex-Exploración Y Producción, No. 13-4022, 2016 WL 4087215, at *1, 10-11 (2nd Circuit, 2 August 2016).
  9. Idem.
  10. See Elisabeth Eljuri, Clovis Trevino, ‘Energy Investment Disputes in Latin America: The Pursuit of Stability.’ 33 Berkeley Journal of International Law 306, 334 (2015), available at http://scholarship.law.berkeley.edu/cgi/viewcontent.cgi?article=1506&context=bjil.
  11. See Bolivia’s Constitution of 2009, Comparative Constitutions Project, at Article 320, Section II (13 August 2014), available at www.parliament.am/library/sahmanadrutyunner/Bolivia.pdf.
               Article 320 further provides that the ‘state acts independently in all of its decisions on internal economic policy, and shall not accept demands or conditions imposed on this policy by states, banks or Bolivian or foreign financial institutions, multilateral entities or transnational enterprises’.
  12. Idem at Article 366.
  13. See National Assembly Legislative and Oversight Committee, Official Register of the Republic of Ecuador, Constitution of the Republic of Ecuador, at Article 422 (Political Database of the Americas trans, 31 January 2011) (20 October 2008), available at http://pdba.georgetown.edu/Constitutions/Ecuador/english08.html.
              The law, however, provides that ‘treaties and international instruments that provide for the settlement of disputes between states and citizens in Latin America by regional arbitration entities or by jurisdictional organisations designated by the signatory countries are exempt from this prohibition.’
  14. See Mexico Hydrocarbons Law, Thompson & Knight Impact, at Article 21 (June 2014), available at www.tklaw.com/files/Publication/5f93e40d-fc4d-445c-b7f9-7dc1cc20b56e/Presentation/PublicationAttachment/9b630df7-5e9e-4e9c-a2f6-80af30e552ff/Mexico-Hydrocarbons-Law-English-Translation.pdf.
  15. Idem.
  16. See footnote 11.
  17. Idem.
  18. Idem at pp. 334–335.
  19. Idem at pp. 335.
  20. See, for example, Fernando Prada, ‘World Bank, Inter-American Development Bank, and Subregional Development Banks in Latin America: Dynamics of a System of Multilateral Development Banks.’ Asian Development Bank Institute, pp. 5-7 (September 2012), available at https://www.adb.org/sites/default/files/publication/156235/adbi-wp380.pdf.

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