"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well." -Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Tuesday, April 1, 2014

D6 Cost Recovery Arbitration: SC appoints Foreign Arbitrator

The Supreme Court's decision yesterday nominating a foreign national as arbitrator in the dispute between the Reliance-BP-Niko Consortium (RIL Consortium) and the Ministry of Petroleum and Natural Gas (UoI) regarding cost recovery in the D6 Block has been reported by several news papers (see here and here, for example). But for a few aspects, the case does not necessitate a lengthy and complicated legal analysis. Hence, these noteworthy aspects are discussed in this post apart from a brief description of the case.
Brief Facts:
UoI entered into a Production Sharing Contract (PSC) for petroleum exploration and production with Reliance Industries Limited (Reliance) and Niko Resources. Subsequently, British Petroleum also became a member of the RIL Consortium. Disputes arose between UoI and RIL Consortium regarding the right of UoI to restrict recovery of costs incurred by the consortium from the petroleum production in the block owing to fall in production levels. In November 2011, Reliance invoked arbitration under the PSC and nominated Justice SP Bharucha as the arbitrator. Initially, UoI stated that arbitration was prematurely invoked as there was no dispute between the parties. Reliance disagreed in view of the "long standing controversy" between the parties. Correspondences ensued. Subsequently, in April 2012 Reliance and Niko filed a petition in the Supreme Court for appointment of arbitrator by UoI. During the pendency, Justice VN Khare was appointed as arbitrator by UoI. Hence, the petition was disposed of. Since both parties had no objection to the arbitrator appointed by the other side, the court ordered that the arbitration clause pertaining to appointment of the third arbitrator may be followed. However, both the arbitrators failed to agree on the third arbitrator for almost a year since the order of the Supreme Court. Therefore, Reliance filed a petition under Section 11(6) of the Arbitration and Conciliation Act, 1996 (1996 Act) for appointment of the third arbitrator.
Justice SS Nijjar who heard the matter "discretely conducted a survey to find a suitable third arbitrator who is not a National of any of the parties involved in the dispute" and appointed Justice James Spigelman, former Chief Justice & Lieutenant Governor of New South Wales, Australia as the third arbitrator and Chairman of the arbitral tribunal.
The decision to appoint the third arbitrator is straightforward and not controversial, especially since the issue was to whether there was a dispute between the parties was resolved in the previoust arbitration petition. However, the following aspects merit dicussion:
  • Right of the Operator to invoke arbitrator on behalf of the Consortium in the Production Sharing Contracts.
  • Appointment of foreign national as arbitrator in International Commercial Arbitration.
  • Power of a party nominated arbitrator to tender legal advice
Right of the Operator to invoke Arbitration:
The Operator is a party of the Consortium which forms the Contractor in Production Sharing Contracts. The Operator acts on behalf of the Consortium in the day-to-day operations of the work under the PSC. The Operator is generally nominated owing to its participating interests (stake) in the Contractor or due to its expertise. Often, the Operator invokes legal action, including arbitration, either against the UoI or against a Contractor. The question that often arises is whether the Operator can do so even on behalf of the parties when there is no express authorisation from the other parties to do so. For instance, in this case, all the correspondences, including the notice invoking arbitration were addressed by RIL without even mentioning that RIL was acting on behalf of the Consortium. Further RIL and Niko had petitioned the Supreme Court for appointment of UoI's arbitrator when by that time the Government had approved assignment of 30% participating interests of RIL to British Petroleum. Another issue was that Niko and BP did not even dispute the inadmissibility of cost recovery by the UoI. These aspects were pointed out by UoI but opposed by the RIL Consortium. However, Justice SS Nijjar disagreed with these for the following reasons:

"52. It is also not possible to accept the submission of  Mr. Anil Divan that Niko and BP are not operators under the PSC and, therefore, have forfeited any right to operations under the PSC. It is also not possible to accept the submission that Niko and BP are not the parties to the dispute with the Respondent. I am of the considered opinion that the provisions of the PSC clearly identified the parties to the PSC. The disputes that have arisen between the parties are also clearly identified in the correspondence exchanged between the parties. The three named contractors are, in fact, frequently mentioned in the correspondence between the parties. It has been correctly highlighted by Mr. Salve that the terms of the PSC have to be considered in the light of the fact that the Respondent expressly consented, after detailed inquiry, to the assignment of participation interests in the PSC to BP. It is a matter of record that Niko has been a party to the PSC from the beginning. Therefore, at-least at this stage, it would not be possible to accept the submission of Mr. Divan that BP and Niko are not "operating” under the PSC."

While the conclusion reached by the Court was correct, the reasonings do not reflect a correct understanding of the PSC. Following are the reasons:
  • Under the PSC, a party is nominated as the Operator by the Contractor. Even in this case, RIL was the Operator (Para 5 of the Judgement). When so, how could it be said that Niko and BP were also operators (See the first and the last lines of the above quote).
  • Merely because UoI consented to the assignment of participating interests by Reliance to BP does not make it a party to the arbitration. It is possible that one party constituting the Contractor might have a dispute while the other Contractor parties may not be a party to such dispute (Eg. Canoro Resources v. Union of India). For instance, UoI may terminate the PSC vis-a-vis a Contractor party for non-compliance of the PSC obligation to seek approval prior to assignment of participating interests. In such a case, such party alone may invoke arbitration against termination.
  • Merely because BP and Niko were mentioned in several correspondences between RIL and UoI would not make them parties to the arbitration.
  • The question as to whether BP and Niko had invoked arbitration or not is a question which should have been decided by the court under Section 11. Unless arbitration was invoked, there is no question of exercise of power under Section 11. This question clearly comes within the scope of "the existence of the condition for the exercise of his power" as provided in Para 46(iv) of the judgement in SBP & Co. v. Patel Engineering.
The eventual decision that BP and Niko were parties to the dispute is correct. Under the Joint Operating Agreement (JOA) between the members of the RIL Consortium, of which UoI had notice (para 6), the scope and authority of the Operator would be provided. In the said JOA, the Operator would be authorised by the consortium members to act on behalf of the parties. The JOA generally specifies those issues for which prior approval is required from the parties and those issues for which the Operator is merely obligated to inform the members. Hence, the Operator would have had the authority to invoke arbitration. Secondly, the issue of disallowance of cost recovery impacts not only the  Operator but also all the parties to the Consortium. This being the situation, unless there was an express stance that BP and Niko disagreed with Reliance's stance, it could be presumed that they agreed with the stance of Reliance and authorised Reliance to proceed. Thirdly, in the Petition filed for appointment of the second arbitrator, Niko was also a party. Conseuqently, it cannot be contended that Niko did not agree with Reliance's stance (It is however, not clear why BP did not join the petition, especially when the PSC was also amended much prior to the filing of the said petition.). UoI wrote a letter in May 2012 addressed to all the parties forming the Contractor in the PSC and not just Reliance alone contending that the Contractor had breached the PSC (para 15 of the judgement). Further, Para 14 of the judgement of the SC clearly recognises that the "Petitioners", that is, RIL Consortium had denied vide letter written to UoI in June 2012 the contentions of UoI that they had breached the PSC. In reply, UoI wrote in July 2012 calling upon the petitioners, Niko and Reliance to withdraw the arbitration petition filed for appointment of UoI's arbitrator. These circumstances clearly point out that Niko and BP were also disputing parties in the arbitration.
Appointment of foreign national as arbitrator in International Commercial Arbitration:
The Supreme Court deviated from its practice of disregarding the spirit of Section 11(9), which provides that in case of International Commercial Arbitration the court "may appoint an arbitrator of nationality other than the nationalities of the parties where the parties belong to different nationalities." and appointed a foreign arbitrator. Section 11(9) recognises the concept of neutrality in international arbitration. However, the Supreme Court has disregarded the same in the past and had appointed retired Supreme Court judges as arbitrator.

This was not always the position of the court. The Supreme Court considered the word "may" in Section 11(9) to mean "shall" in Dolphin International Ltd. v. Ronak Enterprises Inc. 1998(2) Arb LR 313 (SC)and appointed a person of neutral nationality. While doing so, the judge noted that when the matter was previously listed before Justice Punchhi, he had orally observed that "may" in that section should read as "shall". This was the basis for the court to come to such a conclusion. In Malaysian Airlines Systems Bhd (II) vs. M/s. STIC Travels (P) Ltd. AIR 2001 SC 358, the Supreme Court held that Section 11(9) was not analysed in detail in Dolphin International and that if the foreign party did not object to the appointment of a non-neutral party, there was no reason why an Indian arbitrator should be appointed. It was further held that nationality of the parties should be one of the factors while deciding the arbitration but not the sole factor.

In Grid Corporation of Orissa Ltd. v. AES Corporation (2002) 7 SCC 736, the question was whether the decision of the two party appointed arbitrators to appoint the a neutral third arbitrator was under the mistake of Indian law. The Supreme Court took note of the Malaysian Airlines decision wherein it was held that "may" in Section 11(9) is not "shall" but importantly, the court went on to hold that "there is nothing wrong in the two arbitrators having formed an opinion inconsultation with each other that a person of third nationality would bepreferable as presiding arbitrator." Thus, till 2002, the prevailing view on Section 11(9) was that in appointing the third (or the sole arbitrator) nationality of the parties is a relevant consideration; the exception being that where the foreign party did not object to the appointment of an Indian arbitrator an Indian arbitrator could be appointed disregarding Section 11(9).

It was only in MSA Nederland B.V. v. Larsen and Toubro Ltd. (2005) 13 SCC 719 that the interpretation of Section 11(9) took a new turn. In that case, the Supreme Court misread Grid Corporation as holding that it was not mandatory for the Supreme Court to follow Section 11(9) when Grid Corporation did not state so at all. Consequently, MSA Nederland insofar as it permitted to deviate from Section 11(9) for no reason is not good law. In the present case, the Supreme Court tried to distinguish Malaysian Airlines and MSA Nederland by stating that these cases "can not be read to mean that in all circumstances, it is not possible to appoint an arbitrator of a nationality other than the parties involved in the litigation." (Para 72) The court also recognised that "the trend of the third arbitrator/ presiding officer of a neutral nationality being appointed is now more or less universally accepted under the Arbitration Acts and Arbitration Rules in different jurisdictions." (Para 73) The court's views can be restoring the original position that neutrality is a relevant consideration in such a petition. 

It is to be noted that the correct position is that that the court should, by default, ensure appointment of a neutral national as arbitrator. This is so, considering the well-settled practice of appointment of a neutral national as the sole arbitrator or the third arbitrator in a three member tribunal  However, in case the parties express their consent to appoint a non-neutral national, Section 11(9) should not operate against the autonomy of the parties. It is possible that parties might have agreed to a non-neutral arbitrator in view of the additional travel, venue and related costs incurred in appointing a foreign arbitrator, especially if the seat is India.
Power of a party nominated arbitrator to tender legal advice:
The judgement also raises this interesting question as to whether a party nominated arbitrator can tender legal advice to such party in relation to the appropriate time to approach the court under Section 11 of the Act. In this case, when Justice Bharucha and Justice VN Khare could not agree on the third arbitrator for a long time, Justice Bharucha wrote to Reliance: "In these circumstances, you must consider whether the court should be approached for the appointment of a third arbitrator." With utmost respect, it was not necessary for the party appointed arbitrator to advise Reliance to consider whether it should approach the court for the appointment of the third arbitrator. It would have been enough for the arbitrator to simply state that the arbitrators could not agree on the third arbitrator. Although this does not indicate any bias, such an advice is beyond the function of the arbitrator and could have been avoided. It may be noted that this is not an isolated incident. In fact, in Grid Corporation of Orissa Ltd. v. AES Corporation (2002) 7 SCC 736, the Supreme Court notes:

"13. On 1.2.2002, the petitions (sic petitioners) appointed Justice S.C. Mohapatra,retired Judge of High Court of Orissa and Allahabad and former Chairmanof Orissa Administrative Tribunal as their Arbitrator in place of Mr. Verma,in view of his having withdrawn from arbitration. On 1.2.2002, JusticeS.C. Mohapatra addressed a communication to Mr. Donovan requestinghim to agree for the appointment of a former Judge of Supreme Court ofIndia (named in the letter) to be the third Arbitration. It is also stated that ifMr. Donovan was not agreeable then the petitioners would move the ChiefJustice of India under Section 11 of the Act for appointment of a thirdarbitrator. Copy of the communication was endorsed to Mr. Williams also." (emphasis added)

Here, the party appointed arbitrator threatened the other party appointed arbitrator that if the latter did not agree for an Indian arbitrator, the party which appointed the former arbitrator would petition the Supreme Court under Section 11. With immense respect, it is submitted that it was not right on the part of the said arbitrator to act as a counsel of the party which appointed such arbitrator.

The decision of the Supreme Court can be accessed from here and here (pdf).

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