PSC Awards: Great Eastern Energy Corporation v MoPNG

In July this year, we made public an arbitral award in the arbitration between Selan Exploration and the Ministry of Petroleum and Natural Gas (MoPNG). We had assured our readers that we would be bring a few such arbitral awards to the public domain considering their precedential and academic value.

In this second post in the series, we bring to the public domain the arbitral award in the disputeb between Great Eastern Energy Corporation Ltd. (Great Eastern) and the MoPNG. The central issue in the dispute was the quantum of signature bonus to be provided by Great Eastern to the MoPNG. The three member arbitral tribunal upheld the stance of the MoPNG and directed Great Eastern to pay the amount claimed with interest. The arbitral award can be accessed from the below link:

Great Eastern Energy Corporation Ltd. v. MoPNG

PSC Awards: Selan Exploration v MoPNG

We bring to readers certain arbitral awards which have been rendered under the Production Sharing Contracts between the Ministry of Petroleum and Natural Gas and the Contractor(s). The purpose of doing so is to bring these awards to the public domain as it throw light on how Production Sharing Contracts are interpreted. It is expected that these awards would be useful to litigants as well as academicians.

The first of this series is the award pursuant to arbitration between Selan Exploration v. Ministry of Petroleum and Natural Gas. The dispute pertained to share of profit petroleum between the Contractor and the Government. The case also deals with the calculation of the Investment Multiple which forms an integral part of the Production Sharing Contract. The award can be accessed from here.

SC Withdraws Appointment of Foreign Arbitrator in D6 Cost Recovery Arbitration

In a recent post, we had commented on the judgement of the Supreme Court on Monday (31.03.2014) appointing a foreign arbitrator (Justice Spigelman, Australia) as the third and presiding arbitrator in the arbitration proceedings under the Production Sharing Contract between RIL Consortium (consisting of Reliance Industries Ltd., British Petroleum and Niko Resources) and the Ministry of Petroleum and Natural Gas, Government of India. The matter was once again mentioned in the Supreme Court on Wednesday (02.04.2014) by the counsel for the Government of India wherein it was contended that the arbitrator appointed by the Supreme Court was in fact the first in the list of arbitrators submitted by RIL Consortium. The counsel for RIL Consortium agreed and therefore the judge had no other option but to withdraw the order of appointment. 

The appointment became a controversy because the judge had in his judgement stated that he had conducted an independent "survey" in finding a suitable arbitrator. In the withdrawal order, the judge stated that a "substitute arbitrator shall be appointed subsequently by a separate order." The withdrawal order can be accessed from here. News reports on the withdrawal can be accessed from here and here. 

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. 

Decision: 

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.

Comments:

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 discussion: 

• 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).

Relationship between Operator and the Non-Operators in Petroleum Operations

In the last post, we had discussed the decision of the Delhi High Court in HLS Asia Ltd. V. Geopetrol International Inc. & Ors where it was held that although the Non-Operators may not have been party to the contract between the Operator and the Contractor which contains the arbitration clause, they would be necessary parties to the arbitral proceedings in light of the interrelationship between the Operator and the Non-Operators as the members of the Consortium in terms of the Production Sharing Contract (JOA) and the Joint Operating Agreement (JOA). This series of short posts discusses this interrelationship between the Operator and Non-Operators. In this post, the concept of Operatorship in general is analysed.

Concept of Joint Operations:

Petroleum exploration is a highly risky business. Typically, such a company will encounter the following risks:

• Geological risks- risk of not finding any petroleum in commercially viable quantities
• Financial risks- risk that exploitation of the commercially viable quantities of petroleum is far complicated and therefore costlier than initially estimated or change in the economic laws of the host nation drastically increasing the costs to be expended
• Political risks- instability in the region such as civil war, riots, etc thereby resulting in loss of investments.

The business is characterised by high input costs, and when there is commercial discovery, huge profits. Considering the high risks and costs, it is common for two or more parties to share the risks inherent in the business. The term “Contractor” in the Indian context is employed to collectively denote the companies engaged in petroleum exploration. Although the risk is shared, the same is always not equal. Each Party comprising the Contractor generally commits itself only to a certain amount of risk in the exploration project. Consequently, it is entitled to the reward only to the extent of the percentage of the risk shared. Such percentage is known as Participating Interest. Thus, all the rights and all obligations of whatsoever nature including privileges, entitlements, duties, penalties, etc are shared between the consortium members in accordance with their Participating Interest percentage. The percentage of Participating Interest held is recorded in the PSC as well as in the JOA.

Relation between Operator and Non-Operators:

In order to conduct the petroleum operations smoothly and in a focussed manner, a member of the consortium, usually the party having the highest participating interest and resources, is nominated as the Operator. The Operator is responsible for performing virtually all the operations, obtain approvals, comply with laws, employ contractors, and do all activities necessary to perform the petroleum operations. In performing these obligations, the Operator acts not only on behalf of itself but also on behalf of the Non-Operators. The Operator is also authorised to enter into contracts on behalf of the consortium. Thus, the Operator, apart from acting on its behalf, also acts for, or, represents the Non-Operators in dealings with third persons.

Although the Operator is authorized to act as the agent of the Non-Operators, the contours of such authority are delineated by the JOA. In addition, a body called the Operating Committee consisting of representatives of all members of the consortium (typically) is constituted to supervise the functioning of the Operator. Certain important actions in conducting petroleum operations require express authorization from the Operating Committee. Three possibilities exist as regards approval of Operating Committee for awarding contracts:

1. the JOA authorizes the Operator to award contracts without the approval of the Operating Committee,
2. the JOA authorizes the Operator to award only contracts below a specific value without the approval of the Operating Committee, and
3. the JOA requires all contracts to be approved by the Operating Committee. In such cases, the Operator is bound to follow relevant procedure, as applicable. If no consent is taken when the JOA makes it mandatory, the Non-Operators would be entitled to refuse to share the costs and risks for such contracts.

Since the Operator is authorized to enter into contracts to conduct petroleum operations, it is expected that claims or legal proceedings may be initiated against the Operator. Generally, the Operator is authorized to represent the members of the consortium in defending legal proceedings. In doing so, the Operator is mandated to obtain the approval and direction of the Operating Committee in proceedings with such legal proceedings. Costs expended for defending the said proceedings are shared by the members proportionate to their Participating Interest. However, the Non-Operators are not prohibited from appointing their own counsel, in which case, the resultant costs are borne by the Non-Operators. In case a claim is initiated against a Non-Operator by a third party in respect of the petroleum operations, the Non-Operator is entitled to defend the same but in consonance with the directions of the Operating Committee and the costs expended for the same would be shared as per the Participating Interest.

In all, while performing the role of Operator, whether in conducting petroleum operations or in dealing with the government or third parties for the purposes of petroleum operations, the Operator acts as agent for the Non-Operators. Consequently, the general principles of the law of agency are applicable. It may be noted that the JOA grants restricted authority to the Operator to act as agent. Such authority is also circumscribed by the directions of the Operating Committee as provided by the JOA. Thus, subject to the JOA, the Operator is entitled to all the rights of an agent available under law. Such rights include the right to be indemnified by the Non-Operators against consequences of acts which are lawful and acts done in good faith, right to retain expenses incurred and his remuneration from moneys collected by him on behalf of principal, etc. At the same time, the Operator is, subject to the JOA, obligated to perform the duties of an agent as per law.

The above discussion generalises the concept of Operatorship prevailing in the petroleum industry. In the next post, the concept of Operatorship as found in some of the standard formats of agreements used in the petroleum industry would be discussed.

Non-Operators as Parties to Arbitral Proceedings against Operator

Recently, a Single Judge of the Delhi High Court in HLS Asia Ltd. V. Geopetrol International Inc. & Ors., MANU/DE/5356/2012 held that it was necessary that each member of a consortium be made party to arbitral proceedings initiated by the Contractor Petitioner when the Operator to the Consortium had acted on behalf of the consortium. This decision is significant as there are two views concerning the question as to whether the Petitioner has to invoke arbitration against all members of the consortium or merely against the Operator when the contract was executed by the Operator and the Petitioner. One view is that the Petitioner should proceed against the Operator and the Operator can claim from other members of the consortium (hereinafter “Non-Operators”) in accordance with the participating interest of each member to the consortium. The second view is that the Petitioner should invoke arbitration against all members of the Consortium as the contract was executed by the Operator on behalf of the Consortium. The Delhi High Court has held that the Petitioner is entitled to invoke arbitration against all the members of the Consortium. This post analyses the said decision.

Facts:

A consortium consisting of Geopetrol International Inc. (GII), National Thermal Power Corporation Ltd. (NTPC), Brownstone Ventures Ltd. And Canoro Resources Ltd. entered into a Production Sharing Contract (PSC) with the Government of India for exploration of petroleum block in Arunachal Pradesh. The said members of the consortium entered into a Joint Operating Agreement (JOA) to govern their inter se relationship. GII was nominated as the operator for conducting petroleum operations. The Operator was responsible as per the JOA to conduct the day-to-day petroleum operations in the Block and was authorized to enter into contracts on behalf of the consortium but in accordance with the JOA and the PSC. Pursuant thereto, GII entered into a contract with HLS Asia Ltd. (HLS) for wireline logging services to be provided by HLS. Preamble to the contract noted that GII, the Operator, was acting on behalf of the members of the Consortium and that each member of the consortium was jointly and severally liable and only to the extent of its participating interest.

Disputes arose between HLS and GII. Consequently, HLS invoked arbitration under the proceedings. Subsequent to the filing of statement of claim by HLS, GII stated to the tribunal that all the members of the consortium had to be impleaded. Consequently, notices were sent by the tribunal and all the Consortium members were impleaded by it.

NTPC objected to the same and stated that it could not be compelled to participate in the arbitral proceedings. GII countered and stated that the contract was entered into with HLS in its capacity as operator of the Block on behalf of the members of the Consortium.

The tribunal accepted the contentions of NTPC on the following grounds, against which appeal was filed by HLS under Section 37 of the Arbitration and Conciliation Act, 1996:

"(i) HAL had not produced any documents to establish that the members of the consortium had authorised GII to enter into the contract on behalf of the members of the consortium.

(ii) In the absence of such authority, the members of the consortium could not be held liable under a contract to which they were not a party and which contract had not been signed by them.

(iii) The decisions in Mohan Aluminium Orchards Pvt Ltd v. M.P.E.B. MANU/MP/0717/2002 : 2002 (5) MPHT 429 and Austbulk Shipping SDN BHD v. P.E.C. Limited 2005 (2) Arb. LR 6 (Delhi) relied upon by HAL were distinguishable on facts.

(iv) Since no arbitration agreement existed between HAL and NTPC, NTPC was liable to be deleted from the array of parties."

Against this GII stated to the tribunal that the tribunal did not have jurisdiction to adjudicate the dispute as the claim was against all the respondents, that each of the respondent was liable only to the extent of its participating interest, and that the prayer of the claimant went beyond the scope of the agreement and could be maintained only when all the respondents were made party to the arbitral proceedings. HLS, in the meanwhile, appealed to the court under Section 37. The decision of the court is summarized below:

• The PSC and the JOA (especially Article 4.7(g) and (r), JOA) authorized the Operator to act on behalf of the members of the Consortium to enter into contracts, pursuant to which GII entered into a contract with GII.
• Although NTPC did not sign the said contract, the contract was executed by GII on behalf of NTPC and other members of the consortium.
• Each member to the Consortium was necessarily to be made party to the arbitral proceedings as such move would obviate a subsequent plea by any member to the consortium that it was not bound by the award as it was not a party.
• Even in the recent case of Chloro Controls v. Severn Trent Water Purification Inc., the Supreme Court contemplated the possibility of reference to arbitration of non-signatories to the arbitration agreement. (Our comment on the Chloro Controls case can be accessed from here (Part I) and here (Part II)).

The High Court held:

“Consequently, in the present case, although the individual members of the Consortium may not have been party to the contract between HAL and GII, which contains the arbitration clause, they would be necessary parties to the arbitral proceedings in light of the inter relationship between the Respondents as the members of the Consortium in terms of PSC and JOA.”

Bombay High Court Decides the Natural Gas Allocation Dispute

We have been following the Natural Gas allocation dispute over the past two months. For the uninitiated, check out the previous posts from here, here, here, here, here and here. The dispute was pending before the Bombay High Court for some time. On 8 July 2011, the Bombay High Court has decided the dispute in favour of Union of India. In this post, we summarize the judgement of the judge bench of the High Court consisting of Mohit S Shah, CJ. & Girish Godbole, J.Before that, we briefly note the events that led to the case.

12.07.10        The Ministry of Petroleum and Natural Gas (MOPNG) wrote to Reliance asking it to make pro-rata cuts in the supply of natural gas to all its customers when the production from Reliance Industries Limited’s (RIL) D 6 field was not sufficient to cater to all its customers.

30.03.11        Letter from MOPNG to RIL & Niko (NECO) Ltd. (Niko) noted that there was a marked decrease in the production of natural gas from the D 6 field which has led to substantial cuts in the natural gas quantities supplied to its customers. MOPNG stated that reduction in supply of natural gas (a) had subsidy implications on the fertilizer industry and (b) affected power plants, the domestic gas (Liquid Petroleum Gas & City Gas Distribution) sectors which in turn affected large number of people throughout India. The letter, therefore, directed RIL to supply gas to meet the demand from these sectors. The communication provided further that in case the existing production was insufficient to meet the demand of the sectors, cuts were to be imposed in the particular order among these sectors.

21.04.11          Letter from MOPNG to RIL &Niko (NECO) Ltd. (Niko) reiterating that the direction of the government vide letter dated 30.03.2011 needs to be complied with. The letter noted that in the RNRL v. RIL judgement the Supreme Court had noted that Government owned natural gas till it reached the consumer.

Against this direction, Welspun Maxsteel Ltd (Welspun) and Ispat Industries Ltd (Ispat) filed a writ petition in the Bombay High Court and claimed the following relief:

a) a writ, order or direction in the nature of certiorari calling for the records pertaining to the directives issued by [Union of India-UoI] to RIL and Nikovide letters dated March 30, 2011 and April 21, 2011 [hereinafter referred to as the “Impugned Directives”] and after examining the legality and validity thereof, be pleased to quash the impugned Directives;

b) issue a writ, order or direction in the nature of mandamus directing UoI to conduct an exhaustive investigation into the affairs of RIL and Niko in respect of the extraction of natural gas from the KG D6 fields and to issue appropriate directions to ensure that the maximum production levels from the KG D6 fields are attained;

The interim directions of the Bombay High Court have been covered adequately in the previous posts (here and here). The decision of the Bombay High Court is summarized below.

• The Petitioners (Welspun Maxsteel & Ispat Industries) contend that once the MOPNG made firm allocation of natural gas and asked the Petitioners to enter into Gas Sale and Purchase Agreements (GSPA) with the Contractor (RIL & Niko), curtailment in the supply of natural gas cannot be done. As has been held by the Supreme Court in the case of RNRL v. RIL, ownership of natural gas is vested with the Union of India (UoI), which holds the scarce natural resources in public trust. In the same case, the Gas Utilization Policy of the UoI has been held to be in conformity with the Constitution. Significantly, the decision holds that the UoI has the power "regulate and distribute the manner of sale of natural gas through allotments and allocation which would subserve the best interests of the country." The judgement also states unequivocally that the Production Sharing Contract would "override any other contractual obligation between the contractor and any other party”, including the Gas Sale and Purchase Agreement (GSPA).
• The Petitioners argue that the EGOM's (Empowered Group of Ministers) Policy has been entirely overhauled by the MOPNG. A perusal of the decisions of the EGOM shows that the EGOM had accorded high priority to certain sectors such as fertilizer etc (Core Sectors). Also, as per the decisions of the EGOM, firm allocation to steel plants such as those of the Petitioners would be only after demand from the core sectors were met. Therefore, there is no basis in the Petitioners' contention. Similarly, the contentions of the Petitioners that the MOPNG does not have any power to curtail the supply if the daily production is above 40 mmscmd must fail. In fact, all EGOM decisions empower the MOPNG "to take decisions regarding the supply of natural gas to sectors/individual customers consequent to gas being available on account of short offtake, delay and any other unforeseen circumstances." (Emphasis in the original) The EGOM has laid down the broader policy regarding the determination of core and non-core sectors, the overall principles regarding supply allocation and distribution and has empowered the concerned Ministry, the MOPNG, to implement its decisions in public interest.
• The Petitioners rely on the doctrine of promissory estoppel. According to them, since the EGOM decided on the allocation to the steel industry and when firm allocations were made to the petitioners, the government cannot curtail the supply of natural gas in view of the doctrine of promissory estoppel. The Petitioners contention cannot be upheld. Natural gas is a scarce resource and the decision taken by the MOPNG was in public interest. It has been recognised in several decisions of the Supreme Court, including in Shrijee Sales vs Union of India, Kasinka Traders vs Union of India, M. P. Mathur Vs. DTC and State of West Bengal Vs. Niranjan Singha, that there can be no promissory estoppel against public interest
• In proceedings pertaining to judicial review of administrative action, courts do not review the merits of the decision but merely review the decision making process. The Petitioners have, in effect, asked to court to sit on appeal over the decision of the MOPNG, which is not possible.

[On 18.05.2011, the MOPNG considered the submissions of the Petitioners and others in detail and passed a detailed order reiterating its position in the Impugned Directions. The High Court held that the decision was supported by "reasons which are cogent, germane, in consonance with the policy and law and cannot be termed as arbitrary."]

The court, while concluding, clarified that they were not deciding on the second prayer of the Petitioners (conduct an exhaustive investigation into the affairs of RIL and Niko in respect of the extraction of natural gas from the KG D6 fields) and asked the Petitioners to put forth their grievance before the UoI.

By the way, the court wrongly referred to natural gas as CNG (Compressed Natural Gas). What is explored is natural gas. Natural gas is found alongwith certain impurities. The same is sent through pipelines to a Gas Processing Plant, which basically removes the impurities and is sent further, usually through pipelines. Natural gas is compressed and used in pressurized tanks as fuel.

Gas Dispute, Cairn's Revenge, the Production Sharing Contract: Updates

Lots of things happening in the petroleum arena. I call the petroleum sector an arena because its the most happening sector as far as disputes are concerned!

Gas Allocation Issue:

The Bombay High Court has reserved its judgement on the issue of non-allocation of gas from the Reliance D- 6 Field to the steel industry. We have been following this issue for some time (previous posts from this label). Moneycontrol.com has reported that the Ministry of Petroleum and Natural Gas has filed a reply to the petition of Maxsteel Welspun and others. Key aspects of the response, as per the report are the following:

•  Gas allocation to the fertilizer sector should be prioritized due to the Kharif Season.
• The power sector needs priority because of the extreme summer conditions.
• This action by the Government would lead to savings in subsidy to the tune of Rs. 1251 crores to the government

Against this, it was contended that the Government has completely overhauled the extant policy on natural gas. Further, it was argued that if there was a reduction in gas production, there should be pro-rata cuts by the Government in respect of all sectors.

The steel companies counsel forwarding the point that if there is a reduction in the production of gas from the KG-D6 basin then the oil ministry should form this particular policy of pro-rata cuts for all sectors across the board in the range of 10-15%.

Cairn's Revenge?:

Cairn is now acting like a woman scorned. Readers must be aware of the Cairn-Vedanta deal and how the Government-ONGC combine is still holding both Cairn and Vedanta by their respective kudumis! Now, Cairn India has alleged that ONGC has overstated its gas reserves in the KG-DWN Block 98/2 Block. Cairn India is in fact a part of the ONGC-Cairn consortium that has been given the licence to explore the Block. This allegation makes the Cairn-Vedanta-MoPNG saga more interesting, especially when ONGC is coming up with an FPO. Meanwhile check out a few news reports on the issue- Times of India, Business Standard

PSC:

More trouble in the petroleum exploration business. The Comptroller and Auditor General's office has come up with a 193 page Draft Report on Hydrocarbon Production Sharing Contracts alleging that it has structural flaws, the major one being that the PSC encourages more capital expenditure by the Contractor thereby reducing the government's share of the profits from the petroleum produced. Check out this news report. This blawgger couldn't get hold of the report but if anyone has a copy of it, please mail it to lawbadri@gmail.com so that we could do a series of posts on the report.

Update on the Gas Allocation Issue

Business Standard has reported that the Bombay High Court has asked the Ministry of Petroleum and Natural Gas (MoPNG) to state whether they would be able to supply natural gas to Welspun Maxsteel and Ispat Industries. For those new to this blog and to the gas allocation issue, the Ministry of Petroleum and Natural Gas had directed Reliance Industries Limited, the operator of the Reliance D 6 Field, to supply gas only to select core sectors considering the shortage in supply of gas. Steel industries, which used natural gas, were denied supply of the same from the D 6 Field. Therefore, some steel companies had challenged the said decision before the Bombay and the Delhi High Courts. Recently, the Delhi High Court had asked the Empowered Group of Ministers (EGoM) to explain its position on the issue through an affidavit.

Yesterday, the Bombay High Court has asked the Government if it would be able to allow supply of gas to the petitioners, Welspun Maxsteel and Ispat Industries. This was consequent to the petitioners’ argument that the decision would result in closure of the plant and would also lead to a Rs. 1,000 crore loss of exchequer. Implying that the Government’s decision was harsh, Justice Shah is reported to have stated: “Sometimes government does not realize. If an industry shuts down, it is very difficult to revive”.

The dispute is definitely interesting to followers of the petroleum industry. So far in the history of Indian lex petrolea, the Government has been exercising virtually untrammelled powers as regards the petroleum sector. Even the courts have not questioned this. Examples are Association of Natural Gas Industries [(2004) 4 SCC 489] and Reliance decisions of the Supreme Court. However, it appears that the Bombay High Court seems to be of the view that the impugned decision is harsh, as the abovwe quote of Justice Shah would show.

The Government is fighting against these petitions before the Delhi as well as the Bombay High Courts. To prevent inconsistent decisions, it would be prudent for the matter to be transferred to either of these courts.

Updates on the Gas Allocation Issue and the Indus Water Treaty Dispute

The Gas Re-Allocation Issue
Over the past few months, Directorate General of Hydrocarbons (DGH) has been asking Reliance Industries Limited (RIL) to increase its gas production in the KG D6 Field. The direction from the DGH to RIL is in the wake of a slump in the production from the said Field and the increasing demand from the industry. Due to this, the MoPNG had no other alternative but to allocate the gas from the Field to the “core” sectors and deny supply to non-core sectors such as the steel industry etc. Several steel companies such as Essar Steel Limited, Welspun Maxsteel and others had challenged MoPNG's Direction before the Delhi and the Bombay High Courts. We had covered this in three posts (here, here and here). We had noted in our latest post that the MOPNG was firm in its position on gas allocation exclusively to the core sectors.

In one of our previous posts, we had noted that the Delhi High Court refused to grant an interim stay on the MoPNG direction to allot the gas exclusively to core sectors (Direction). It may also be noted that Welspun Maxsteel and others have filed a petition before the Bombay High Court challenging the same direction. It would be prudent for the matter to be transferred to either of the two High Courts.

In the proceedings before the Delhi High Court, one of the grounds for challenging the Direction was that the MoPNG was not competent to alter the allocation of gas done by the Empowered Group of Ministers (EGoM). Consequently, the counsel of Essar Steel reportedly prayed the court to order the matter to be decided by the EGoM. The Business Standard reports that even the court was of the opinion that it was better if the EGoM made a decision. An EGoM meeting was scheduled to be held on 9 June 2011. However, the meeting was cancelled. Ultimately, the Additional Solicitor General agreed to have the matter decided by the EGoM. The order of the Delhi High Court dated 3 June 2011 notes: “Mr. A.S. Chandhiok, learned ASG states that the stand of the EGOM in the matter will be made explicit by an affidavit to be filed on its behalf on or before 4th July 2011.”

Kishanganga Dispute between India and Pakistan
A 10 member court of arbitration, alongwith observers from India and Pakistan would inspect the Kishanganga project on 18 June. We have been providing updates on the issue. All the posts on this issue can be accessed from this label.

Natural Gas Allocation in India: Latest Development

We have been following the latest developments on the dispute between some steel producers and the Ministry of Petroleum and Natural Gas on the allocation of natural gas. Certain steel companies had filed cases before the Delhi and the Bombay High Courts challenging the direction of the Ministry of Petroleum and Natural Gas to Reliance Industries Limited to sell gas to priority sectors. We had a post describing the entire dispute and it can be accessed from here. On May 11, the Petroleum Ministry had called for a meeting to hear the grievances of the steel producers. In the said meeting, the Ministry had stated that it would take a decision on the issue by May 18.

Business Standard and the Times of India report that the Ministry has stuck to its initial decision to prioritise gas sale from Reliance D6 Field to the priority sectors first and then only to the Non-priority sectors. The reason that the Ministry had given is reportedly that the production from D6 was below expectations and that the interest of the core sector cannot be sacrificed.

It may be noted that news reports state that the Petroleum Ministry and its exploration regulatory arm, the Directorate General of Hydrocarbons had already asked Reliance Industries Limited to drill two wells by June.

The same issue is pending before the Bombay High Court and is coming up for hearing on 23 May. We'll keep our readers updated on the issue.

Gas Allocation & Utilization in India: Further Developments

In our last post, we had dealt with the case pertaining to allocation of natural gas. In the case filed by Welspun Maxsteel and Ispat, the Bombay High Court had directed the Government to hear the concerns of the petitioners. The counsel for the Government stated in the court that the Government would hear the petitioners as well as others who were affected by the directions given to Reliance to supply gas only to priority sectors. Pursuant thereto, the Government has called for a meeting to be conducted today (May 11, 2011) chaired by the Joint Secretary (Marketing), Ministry of Petroleum & Natural Gas for hearing the affected parties.

Natural Gas Allocation and Utilisation in India: Matter Goes to Court

Reliance D 6*

Several newspapers in the last few days have reported petitions against the Ministry of Petroleum & Natural Gas, Government of India (MOPNG), for prioritizing the allocation of natural gas from the Reliance KG-D6 to specific industries. Essar Steel has, reportedly, filed a petition before the Delhi High Court against the order of the MOPNG dated April 21, 2011 (Direction) allocating gas from Reliance’s KG D6 Field to “priority” sectors such as fertilizers, power etc, and only after the demand in the sectors are met, to sectors such as steel, petrochemicals and refineries.The per day demand of priority sector seems to be around 47.6  million metric standard cubic meters per day (mmscmd). The Direction seems to empower Reliance to cut off supplies to non-priority sectors if the natural gas demand of the priority sectors has not been met. Consequently, Reliance Industries Limited (RIL) has reportedly cut off the natural gas supply to such non-priority sectors from this Monday (10.05.2011).

About 3.2 mmscmd gas was supplied from D6 to Essar Steel. However, of late, D6 field has not been producing enough natural gas, leading to strict directions from the Exploration & Production regulator-Directorate General of Hydrocarbons to RIL. This Direction is a possible consequence of the low production. Essar Steel challenged the Direction to RIL. Essar Steel had also asked for an interim stay on the direction of the MOPNG. However, the Delhi High Court refused to grant stay without hearing the Government. When the court asked for the contentions of the Government with the Additional Solicitor General, Mr A.S. Chandiok (ASG), the ASG asked for more time to review the decision of the Bombay High Court on a similar matter that arose out of petitions filed by Welspun Maxsteel and a few others.

Proceedings before the Bombay High Court:
The Direction was also the subject matter of a petition filed in the Bombay High Court by Welspun Maxsteel. Relevant portions of the impugned Direction dated April 21, 2011 reads as follows: 

“2. Under the Government's Gas Utilization Policy, allocations for KG D6 fields had initially been made for core sectors and subsequently, taking into account expectation of higher production, allocations had been made for non-core sectors. As the gas production from KG D6 fields has decreased to around 50 mmscmd, it is only natural that the said production be supplied firstly to core sectors and Ministry's direction vide letter of even number dated 30.03.2011 has been issued in this context. The said direction has been issued in pursuance of Government's Gas Utilization Policy under the provisions of the PSC. Hence, the said direction needs to be complied with.
3. The Hon'ble Supreme Court in its order dated 7.5.2010 in the RIL & RNRL case has held that the Government owns the gas till it reaches its ultimate consumer. Further, it has been held that the PSC shall override any other contractual obligation between the Contractor and any other party.”

It may be noted that he MOPNG has been deciding on the allocation of natural gas to different sectors for a long time. As regards natural gas from the D6 Field, Government had, though an EGoM (Empowered Group of Ministers), framed a policy, known as Gas Utilisation Policy (June 2008), for the allocation of gas to various sectors. The said policy also contained certain general directions for the allocation of natural gas in respect of all NELP (New Exploration Licence Policy) Production Sharing Contracts. Following are the features of the general guidelines:

• The marketing priorities for the sale of gas from NELP Blocks would be determined by the Government and the sale would be on the basis of pricing formula approved by it.
• Gas allocation to a particular sector would not mean reservation or quota to that particular sector. In case consumers of a particular priority sector are not in a position to take gas when available, the gas not taken would be first offered to other entities in that priority sector and if they are not in a position to take the gas, the gas not taken would go to the sector which is next in priority.
• The priority for gas supply would be applicable only to customers who are connected to the existing pipelines network. In the absence of a network, a small or marginal field could sell the gas to customers connected to or can be connected to (within a short period of three- six months) it.
• This prioritization would not affect the process of price discovery as all customers would participate in the price discovery process (as per the extant policy of the EGoM) and would be eligible for utilizing natural gas subject to priority.
• This guidelines would be reviewed after five years 

Apart from these general guidelines, the policy prioritized sectors for the utilization of the D6 gas. The priority sectors as per the policy are:

• Gas based urea plants
• Gas based LPG plants
• Liquid Fuel plants and power plants lying idle or underutilized
• City Gas distribution
• Gas based power plants

There are two sources of such power of the Government. One, the Production  Sharing Contract itself gives the Government the right to frame policies pertaining to marketing of natural gas. The relevant provisions in the latest (NELP IX) PSC are as follows: 

"21.1 Until such time as the total availability of Natural Gas from all Petroleum production activities in India meets the total national demand as determined by the Government, each Company comprising the Contractor, shall sell in the domestic market in India all of the Company’s entitlement to Natural Gas from the Contract Area.

21.3 For the purpose of domestic sale obligation, the Contractor shall have freedom to market the Natural Gas and sell its entitlement as per Government Policy for utilization of gas among different sectors. 
21.3.1 For purposes of Article 21, the Government may from time to time frame policy for utilization of gas among different sectors, both for Associated Natural Gas (ANG) as well as Non-Associated Natural Gas (NANG) which would cover issues relating to gas supplies to different consumer sectors."

The second source comes from the Constitution itself. Article 73 read with Entry 53, List I of Schedule VII. Entry 53 reads:

"Regulation and development of oilfields and mineral oil resources; petroleum and petroleum products; other liquids and substances declared by Parliament by law to be dangerously inflammable."

Now, in the Welspun Maxsteel case, it was argued that if no gas was supplied to the petitioners, their manufacturing process would come to a standstill and this would have a cascading effect on the economy. A two judge Bench consisting of Ranjana Desai & Ranjit More, JJ. were of the opinion that the Union of India has to hold a meeting with the petitioners to sort out their grievance. The Bench ordered the matter to be heard on May, 9, 2011. The order can be accessed from here. On May 9, the Vacation Bench consisting of Mridula Bhatkar & RG Ketkar, JJ heard the matter.In the said hearing, the counsel for Union of India stated that a meeting would be conducted on May 11 between the petitioners, representatives of other non-priority sectors affected by the decision of the Government, and the MOPNG and a decision on the matter would be communicated to the petitioners by May 19, 2011. The court adjourned the matter to May 23, 2011. The order can be downloaded from here.

It would be interesting to see what the MoPNG would do. We will keep our readers updated.

* Image from here.

Global Process Systems v. Syarikat Takaful Malaysia Berhad ( UK SC, 2011)- II

In the last post, we had discussed about rigs and their transportation on barges. In this post, we’ll discuss certain other technical aspects and also the judgement. The judgement, it may be noted, has a bearing on marine cargo insurance. We'll look into the judgement in this post.

But, to recap, during the voyage of the barge which carried the rig (see this picture), all the three legs of the rig broke of and fell into the sea. The owner of the rig , the insured, made a claim with its insurers for the loss caused. The insurers rejected the claim. The insured sued. The insurers argued that the insurer was not liable for the loss because the loss was caused due to inherent vice. The insurers contended that since the loss not caused by any an unexpected accident or casualty, therefore the loss was proximately caused by inherent vice. This ground of inherent vice was relied upon by the insurers as it was an exception to insurer liability under the contract. Section 55(2)(c) of the English Marine Insurance Act, 1906 also provided:

“Unless the policy otherwise provides, the insurer is not liable for ordinary wear and tear, ordinary leakage and breakage, inherent vice or nature of the subject matter insured, or for any loss proximately caused by rats or vermin, or for any injury to machinery not proximately caused by maritime perils.”

The Commercial Court determined that the loss was due to metal fatigue in the legs. As we discussed in the previous post, the legs in this rig were mat-type legs and therefore the legs were cylindrical structures.Fatigue occurs when there is repeated stress on the legs. According to the court, the stress in the legs were due to the pitching and rolling motion of the barge due to the height and direction of the waves.

An important aspect that had bearing on the case was that there was a risk of fatigue was well known to the insurers and the insured. Therefore, the insurers insisted that the rig be inspected again in Cape Town, South Africa and necessary remedial operations be conducted. On this condition, the insurers granted a certificate approving the voyage. Thus, both knew that the voyage was risky for the rig. Therefore, the insurers took the ground of inherent vice.

It was argued by the insurers that insurance was a contract aimed at protecting against risks and not certainties and since it was certain that the rigs would be affected by metal fatigue, they were not liable for the loss of the legs.

Inherent Vice: as the Proximate Cause
Loss due to Inherent vice means that the loss is caused due to the nature of the goods itself and not due to any external causes.

In Soya GmbH Mainz Kommanditgesellschaft v. White [1982] 1 Lloyd’s Rep 122, Soya beans were to be transported by ship. The goods were insured against the risk of heating, among other things. When the goods arrived to the port, it was in a heated condition. Relying on the ground of inherent vice, the insurers denied liability. Donaldson LJ held that a loss is proximately caused by inherent vice if the natural behavior of the goods is such that they suffer a loss in circumstances in which they are expected to be carried.

However, the House of Lords in the same case [1983] 1 Lloyd’s Rep 122, supplied a different definition. Lord Diplock held :

“[Inherent vice] means the risk of deterioration of the goods shipped as a result of their natural behavior in ordinary course of the contemplated voyage without the intervention of any fortuitous external accident or casualty.”

Now, there is a subtle difference between the above two definitions. To clarify, we would take the soya bean example. If the subject matter, that is, soya beans was wet when it was loaded in the ship, then the insurer is not liable because the subject matter inherently suffers from vice, that is, wetness. The proximate consequence of the heatedness would be the wetness of the subject matter. It was the fault of the insured to not keep the goods away from moisture. Therefore, it is right that the insurers should not be liable.

However, the definition of Donaldson LJ seems to suggest the incapability of the subject matter to stand the expected events of voyage as inherent vice. The UKSC in the present case favoured Lord Diplock’s definition. In T M Noten BV v. Harding –[1989] 2 Lloyd’s Rep 283, Bingham LJ held that the proximate cause of the loss was inherent vice of the subject matter, that is, the goods were shipped wet.

Noting the above decisions and another, the UKSC held:

“[T]hese cases do not provide authority for the proposition that inherent vice or nature of subject matter insured is established by showing that the goods in question were not capable of withstanding the normal incidents of the voyage, including weather reasonably expected. What they do establish is that where the only fortuity operating on the goods comes from the goods themselves, the proximate cause of the loss can be properly be said to be the inherent vice or the nature of the subject matter insured and so (in the absence of provisions to the contrary) falls outside the cover.”

The Court also disagreed with the decision in Mayban General Insurance v. Alstom Power Plants Ltd [2004] 2 Lloyd’s Rep 609, where a transformer, the cargo, was damaged due to the movement of the vessel due to wind and sea action. The court stated that the goods transported must be capable of withstanding the “forces” that could be reasonably expected during the voyage. The court stated that since there was no unusual cause which caused the damage.

This, according to the UKSC, would have the consequence of reducing “much of the purpose of cargo insurance, for the would then only extend to loss or damage caused by perils of the seas that were exceptional, unforeseen or unforeseeable, and not otherwise. This…would go far to frustrate the very purpose of all risks cargo insurance, which is to provide indemnity in respect of loss or damage caused by, among other things, perils of the seas.”

Seaworthiness:

Section 55(2)(c) also states that insurer is not liable for ordinary wear and tear. In Mayban General Insurance, the court implied that insurers would not be liable if the cargo was unseaworthy. Seaworthiness is defined in Section 39 of the Act to mean “reasonably fit in all respects to encounter the ordinary perils of the seas of the adventure insured.” Perils of the seas is defined in the Act to only mean fortuitous accidents or casualties of the seas and does not include action of the winds and waves. Therefore the court implied that seaworthiness did not include the ability of the cargo to withstand wind and wave action.

Seaworthiness of the vessel is an implied warranty in the marine insurance policy. If the vessel is not seaworthy, the insured is not entitled to be indemnified by the insurers irrespective of whether the loss was proximately caused by the unseaworthiness.

The court held, by an analogy to the seaworthiness standard in Section 39, the mere fact that the goods are not reasonably fit in all respects to encounter ordinary perils of the seas of the adventure insured does not by the reason alone deprive the assured of the right to be indemnified.

But then, when the seaworthiness standard in the Act refers to a higher standard, that is, the ability to withstand “fortuitous accidents or casualties of the seas”, does it not mean that seaworthiness would also include a lesser standard, I.e., the ability to withstand wave and wind action would also be covered?

In any case, Section 39 dealt with seaworthiness of a vessel (hull insurance) while the present case dealt with cargo insurance.

Two Proximate Causes:

The insurers also argued, without prejudice, that the loss was caused by two proximate causes- inherence vice and perils of the sea. They relied on a decision that dealt with hull insurance- Miss Jay Jay [1987] 1 Lloyd’s Rep 32 where it was held that where there were two proximate causes, and where the policy excluded one cause from the cover, the assured would not be entitled to be indemnified. While Lord Saville rejected the argument for the reason that it was not the case where there were two proximate causes, Lord Mance did not wish to go into the question without hearing arguments.

In any case, the court held that the rolling and pitching of wave the barge in the sea conditions encountered caused the damage and the insurers were liable for the loss.

 

Comments on the Case:

• INCE & Co., Incisive Risk
• Norton Rose, The true scope of inherent vice - The Cendor MOPU
• Waltons & Morse, The Supreme Court clarifies the scope of application of the "inherent vice" exclusion in cargo insurance
• Case Comment by the UKSC Blog
• Sam Tacey, Ajita Shah, Wave goodby to inherent vice exclusions? (Comment on the Court of Appeal Decision) 
• Shipping and Trade Law Case Update (Court of Appeal Judgement)

Global Process Systems v. Syarikat Takaful Malaysia Berhad ( UK SC, 2011)

Petroleum exploration is a technology-intensive activity. One of the chief equipments used in petroleum operations are drilling rigs. While, rigs built for drilling on land (onshore) are less complex, offshore (in the sea/ ocean) rigs are much more complex and expensive.

The rig in dispute in this case was a self elevating mat supported jack up rig. Jack up rigs are rigs which are self-elevating. These form one of the most popular offshore rigs used throughout the world. Essentially, a jack up rig floats in the water and the legs are jacked up. Once the destination (the drilling site) is reached, the legs of the rig go underwater into the sea bed and elevate the jack up rig floor to a certain height depending upon the depth of the sea water and the length of the legs of the rig. The figure here shows a jack-up rig that is jacked up.

When the drilling operations in a particular location is complete and the rig needs to move to a different location, the rigs are jacked down and are moved to different locations by the use of tugs. Where the next location is too far, the rig is taken on a barge. The below figure shows a jacked down rig on a barge.

Jack up rigs can be either mat type or independent leg type. In case of independent leg type, the tip of the legs consist of spud-cans. Spud-cans cylindrical steel shoes with pointed edges. These penetrate into the sea-bed and make the legs stable.

Jack-up rigs can also have mats instead of spud-cans. Mats consist of a flat surface which is laid on the sea bed and are attached to the edge of the legs.

The legs of the mat supported jack-up rig is cylindrical and is made of steel. Below is an example of how mat type jack up rigs look from the sea bed

In the present case, the legs were of 312 feet in length each and weighted about 312 tonnes. The rig was transported to convert it into a Mobile Offshore Production Unit. The rig was transported on a barge. Usually Production Platforms are fixed structures on the sea. However, it might be advantageous to use a movable platform from cost, convenience and re-use perspectives. Such a movable platform is known as a Mobile Offshore Production Unit.

While the legs were being transported on the barge with the legs extending in the air (see the second figure of the post. The legs are independent leg type. However in our case, the legs were of the mat type rig.

During the voyage, all the three legs broke of and fell into the sea. Syaikit Takaful Malaysia Berhad (STMB) who owned the rig made a claim with its insurers for the loss caused to STMB. Insurers rejected the claim. STMB sued the insurers before the commercial court. The insurers argued that the insurer was not liable for the loss because the loss was caused due to inherent vice. The insurers contended that since the loss not caused by any an unexpected accident or casualty, therefore the loss was proximately caused by inherent vice. This ground of inherent vice was relied upon by the insurers as it was an exception to insurer liability under the contract. Section 55(2)(c) of the English Marine Insurance Act, 1906 also provided:

“Unless the policy otherwise provides, the insurer is not liable for ordinary wear and tear, ordinary leakage and breakage, inherent vice or nature of the subject matter insured, or for any loss proximately caused by rats or vermin, or for any injury to machinery not proximately caused by maritime perils.”

The central argument of the insurers was that the loss was proximately caused by inherent vice in the rig. The court had to consider the validity of this argument. 

The judgement can be downloaded from here. The decision of the court will be analysed in a subsequent post.

(all images from Rigzone- http://www.rigzone.com/training/insight.asp?insight_id=339&c_id=24)

Canoro Resources: Transfer of Operatorship in the Amguri PSC

Earlier this month, we did a descriptive comment on the case of Canoro Resources v. Union of India (posts are here and here). 

To recap, the Government of India had terminated the Production Sharing Contract in respect of Canoro Resources as it had not obtained permission from the Government for an indirect assignment of participating interest. Canoro filed an application for interim measure under Section 9 of the Arbitration and Conciliation Act, 1996 for preventing the Goverment from not giving effect to the termination letter. The Delhi High Court rejected the application.

The Telegraph reports that the Delhi High Court has directed the Oil and Natural Gas Corporation Limited  (ONGC) to take over the operations in the Amguri Block. Now, this issue as to what happens after the PSC is terminated in respect of one party is important and may form precedent in future cases. 

The said news report suggests that the Ministry of Petroleum and Natural Gas had requested the court to for an interim measure ordering Canoro Resources to hand over the operatorship to Assam Company Limited, a partner to the consortium that consisted of Canoro Resources Ltd. (Canoro), Assam Company Limited (ACL) and Joshi Technologies International, with ONGC having the power to monitor the operations.

The High Court, however, passed an order asking ONGC to take over the possession of the Block and to operate the Block. the order can be obtained from this link. The next hearing is on 6 April 2011. We'll follow this case for the interesting issues that arise consequent to termination of the Production Sharing Contract.

The latest Model Production Sharing Contract published by the Government gives some indication:

"PROVIDED THAT where the Contractor comprises two or more Parties, the Government shall not exercise its rights of termination pursuant to Article 30.3, on the occurrence, in relation to one or more, but not all, of the Parties comprising the Contractor, of an event entitling the Government to terminate the Contract,

a) if any other Party or Parties constituting the Contractor (the non-Defaulting Party or Parties) satisfies the Government that it, or they, is/are willing and would be able to carry out the obligations of the Contractor.
(b) where the non Defaulting Party or Parties with the consent of the Government has/have acquired the Participating Interest of the Defaulting Party pursuant to the provisions of the Operating Agreement and has/have procured and delivered to the Government a guarantee or guarantees as referred to in Article 29.1 in respect of the Participating Interest of the Defaulting Party acquired by the non Defaulting Party or Parties.

 It is submitted that many Joint Operating Agreements (those agreements entered into between the members of the consortium forming the Contractor to govern their relationship inter se) do not contain detailed provisions in case such event happens. I am not sure if the Model JOA of the Association of International Petroleum Negotiators (2002) contains a provision governing such an event. JOAs ought to contain provisions to cover a situation where one of the parties is a defaulting party under the PSC.

What Cannot be Done Directly Cannot be Done Indirectly: Canoro Resources Case

In the last post, we had seen the facts of the case of Canoro Resources v. Union of India which deals with assignment of participating interests in a Production Sharing Contract. We analyse the decision in this post. The decision is summarized below:

• Prima facie, a transfer of shares satisfying the conditions specified in Article 29.2 requires the consent of the Government.
• The fact that Article 29.2 does not use the term “prior” is immaterial as Article 29.3 uses the expression “detailed information on the proposed assignee or transferee, the terms of the proposed assignment or transfer”.
• The purpose of Article 29.2 is to cover situations where participating interests are transferred through an indirect method.
• The contracting party is supposed to give detailed information of the proposed assignee so that government can consider and dispose of the application.
• When direct transfer of participating interests without consent is prohibited, even an indirect transfer of participating interests is also prohibited.
• As per Article 31, a breach of Article 29.2 cannot be remedied by the contractor party.
• Article 35 which provides that the contractor party has to inform the government of any material change in the status of the company that affects the performance of PSC obligations does not “whittle down” Article 29.2.
• This is a fit case for lifting the corporate veil to see the economic realities behind the veil.
• Article 31.3 provides that government has to give a notice that it intends to terminate the PSC at least 90 days before the intended date of termination. The actual termination took place beyond 90 days after the show cause notice.
• By its nature, the PSC is determinable.
• There are a few decisions which hold that termination is not justified in view of the expenditure undertaken. However, the termination by the Government is not, prima facie, illegal.
• A sovereign cannot be viewed as having given up its rights permanently when it enters into a contract, specifically when an action by the Contractor threatens the national security of the interests of the state.
• As provided in the Reliance case, petroleum is a strategic resource to the nation and an interpretation of the contract or law which affects the power of the sovereign in respect of such strategic resource would be opposed to public policy.
• The submission that attempts for amicable settlement is a condition precedent for invoking arbitration is not correct. If it is decisive that amicable settlement would fail, there is no need to initiate attempts to amicably settle the dispute. From the facts of the dispute, it appears that Canoro had made attempts for amicable settlement.
• It was not pleaded by the Government that MASS was an undesirable entity.
• The government submitted that the petroleum reservoir was affected due to improper operations. Therefore the court held:

 “In the face of the allegations that the petitioner, post the indirect assignment of participating interest has caused irreparable and irretrievable damage to the oil field, leads me to prima facie conclude that Article 31.6 of the PSC cannot come in the way of the government to terminate the PSC qua the petitioner, when the valuable national resource itself is in danger of being wasted and irretrievably lost by a contractor or its assignee.”

 Thus, the court dismissed the petition for interim injunction under Section 9 of the Arbitration and Conciliation Act, 1996.