Fordham International Law Journal Volume24,Issue4 2000 Article5 International Project Finance and Arbitration with Public Sector Entities: When is Arbitrability a Fiction? Mark Kantor∗ ∗ Copyright(cid:13)c2000bytheauthors. FordhamInternationalLawJournal isproducedbyTheBerke- leyElectronicPress(bepress). http://ir.lawnet.fordham.edu/ilj International Project Finance and Arbitration with Public Sector Entities: When is Arbitrability a Fiction? MarkKantor Abstract This article reviews the events surrounding two prominent arbitration decisions related to twoIndonesiageothermalpowerprojectssponsoredbyCalEnergyCompany,Inc. (”CalEnergy”), knownasthePatuhaandHimpurnaprojects,andaPakistanipowerprojectdevelopedbytheHub PowerCompany, Ltd. (”HubCo”). TheaggressiveinvolvementoflocalcourtsintheCalEnergy and HubCo proceedings does not reassure investors relying on the perceived neutrality of inter- national arbitral institutions to mitigate the risk of uncertain justice in unstable countries. The author asks: Are problems between State entities in troubled developing countries and interna- tional project sponsors simply not arbitrable as a practical matter when economic and political crisis intersect in a highly corrupt economy? Or, are there means of protecting the arbitrability of investor-State disputes in the midst of such turmoil? This review concludes that few devices will be effective to overcome these hurdles. Thus, arbitration may in reality be a fiction in such circumstancesuponwhichinvestorsshouldnotrelyexclusively. INTERNATIONAL PROJECT FINANCE AND ARBITRATION WITH PUBLIC SECTOR ENTITIES: WHEN IS ARBITRABILITY A FICTION? Mark Kantor* Professor Priyatna was visibly upset and said words to the ef- fect that we had worked together closely as colleagues he hoped we would still be friends and that he was sorry but hoped I would understand that he had to leave. I told him that a court ruling in The Hague delivered earlier that day had not stayed the arbitration and that therefore the hearings could continue. He replied that when he was about to leave Washington on Sunday an Indonesian whom he did not know but who presented himself as coming that day from Jakarta to read him a letter said to be from a Minister warning him not to go forward with the arbitrations. He was not given a copy of the letter. Professor Priyatna informed me that when he arrived at Schiphol airport on the morning of Monday 20th September, he was met by a Mr. Warrow who had come from Jakarta to read to him the same letter instructing him not to attend the arbitration hearings. With Mr. Warrow was Mr. Husein of the Indonesian Embassy. Professor Priyatna apologised and said that he had been told he could not telephone or contact either Mr. Paulsson or my- self and was placed in the Ibis Hotel at the airport with Em- bassy personnel. He identified to me at the airport Mr. War- row, Mr. Husein, and a Mr. Hadianto also of the Embassy. Professor Priyatna told me that he was being accompanied back to Jakarta .... He was visibly upset throughout the entire discussion with me * Mr. Kantor recently retired from partnership at Milbank, Tweed, Hadley & Mc- Cloy LLP, where his practice focused on international finance and investment. He is currently writing about a variety of legal and business topics and teaching at Ge- orgetown University Law Center. A qualified arbitrator, he may be reached at [email protected]. 1122 PROJECT FINANCE & ARBITRATION 1123 which lasted about 10 minutes, and for some period was close to tears.1 INTRODUCTION Arbitration over international project financings in develop- ing countries is not a dry topic. Recent high-profile arbitrations about project financings address allegations of bribes, kickbacks and corruption,2 the collapse of entire economies,' wholesale re- jection of contracts,4 political crises and coups,5 claims of human 1. Statement of Mr. Albert de Fina, one of three arbitrators in the cases concern- ing the impact of the suspension by the Government of Indonesia of two geothermal power projects sponsored by CalEnergy Inc. ("CalEnergy"). Mr. de Fina's statement recounted a meeting at Schiphol Airport in The Netherlands with Professor H. Priyatna Abdurrasyid, the arbitrator appointed by the Government of Indonesia, on the day before hearings scheduled by the Arbitral Tribunal in The Hague. See PatuhaP ower Ltd. (Bermuda) v. Republic of Indon. (Interim Award, Sept. 26, 1999), 15 MEALEY'S INT'L ARB. REP. B-1, B-27-28 (2000) [hereinafter Patuha-ROI Interim Award]. That meeting fol- lowed investigatory efforts by Mr. de Fina, Mr. Jan Paulsson (President of the Arbitral Tribunal), and Professor Albert van de Berg to locate Professor Priyatna after learning that Professor Priyatna had failed to arrive at his chosen hotel and that his reservation had been cancelled by a staff member of the Indonesian Embassy. Id. at B-23-28. 2. See HubCo Judgment Transcript in the Supreme Court of Pakistan (AppellateJ urisdic- tion), Civil Appeal No. 1398 and 1399 of 1999, Civil Appeal No. 1398 of 1999, The Hub Power Company Limited v. Pakistan WAPDA and Federation of Pakistan, 16 ARB. INT'L 439, 456-58 (2000) [hereinafter HubCo v. WAPDA], reprinted in 15 MEALEY'S INT'L ARB. REP. A-1 (2000); Patuha Power Ltd. (Bermuda) v. PT. (Persero) PerusahaanL istruik Negara (May 4, 1999), 14 MEALEv'S Ir'L ARB. REP. B-i, B-23-24 (1999) [hereinafter Patuha-PLNF inal Award]. 3. Patuha-PLNF inal Award, supra note 2, at B-30 ("Indonesia found itself in a ca- lamitous economic crisis."). The award quotes counsel to PT (Persero) Perusahaan Listruik Negara ("PLN") as follows: The Tribunal has to address the claims which are before it against the back- ground of the economic collapse that preceded the presidential decrees in the last quarter of 1997 and made them necessary .... In 1998 to 1999, the Indonesian economy contracted by 15 percent, resulting in more than 5 mil- lion workers losing theirjobs. The rupiah ... has lost more than 80 percent of its value since the crisis first erupted .... Out of a population of 200 million, the number of seriously poor people in Indonesia is projected to reach 130 million in 1999 .... Id. 4. Twenty-seven independent power projects ("IPPs") were forced into suspension or renegotiation in Indonesia. See The Future of IndependentP ower Producers, INDON. COM. NEWSL., Dec. 19, 2000. Nineteen Pakistani projects under construction were harassed or cancelled by the Pakistani government. See Hill, A Military Coup Doesn't Change the Fact that Pakistan is Under Contract to Pay Western Power Producersf or Electricity it Can't Af- ford, PROJEur FIN., Nov. 1999, at 109. Intervention into power projects in recent years has not been limited solely to these two countries. For example, in August 1995, the State Government of Maharashtra, India, announced its intention to stop construction 1124 FORDHAM INTERNATIONAL LAWJOURNAL [Vol. 24:1122 rights violations,' injunctions against arbitration,7 and awards in the hundreds of millions of U.S. dollars,8 as well as such outra- geous extra-judicial interference as the forced return of Profes- sor Priyatna from The Netherlands to Indonesia. The most prominent of these decisions relate to two Indonesian geother- mal power projects sponsored by CalEnergy Company, Inc. ("CalEnergy") (now MidAmerican Energy Holdings Company), known as the Patuha and Himpurna projects, and a Pakistani power project developed by the Hub Power Company, Ltd. ("HubCo"). In the two Indonesian transactions, arbitrators con- tinued with proceedings and issued large awards against the Re- public of Indonesia ("Republic" or "GOI") and its State-owned electricity utility, PT (Persero) Perusahaan Listruik Negara ("PLN"), all despite anti-arbitration injunctions issued by an In- donesian court. In the HubCo transaction, conversely, the Pakis- tani Supreme Court upheld an anti-arbitration injunction stop- ping International Chamber of Commerce arbitration proceed- ings brought by HubCo against the Pakistani State-owned of the US$2.8 billion Dabhol power project on the alleged grounds that the electricity tariff was unaffordably high, the project was environmentally unsound and the bidding process was not transparent. See Marcus W. Brauchli, Enron Project is Scrapped by India State, WALL ST. J., Aug. 4, 1995, at A3; see also Danielle Mazzini, Stable InternationalC on- tracts in Emerging Markets: An Endangered Species?, 15 B.U. INT'L L.J. 343, 352-53 (1997). 5. See Hill, supra note 4 (discussing impact on private power projects of replace- ment of Ms. Benazir Bhutto by Mr. Nawaz Sharif as Prime Minister of Pakistan and later coup by General Pervez Musharraf). The fall of President Suharto from power in Indo- nesia is also intimately related to the many power project disputes in that country. See The Future of Independent Power Producers, supra note 4 (noting 14 independent power projects in which Suharto family or friends participated); Evelyn Iritani, The Ties that Bind: Firms Try to Steer Clear of Suharto Family Backlash, L.A. TIMES, June 6, 1998, at D1 (specifying 10 IPPs with ties to Suharto family members or friends). 6. See The Enron Corporation: Corporate Complicity in Human Rights Violations, Human Rights Watch (1999), available at http://www.hrw.org/hrw/reports/1999/enron/in- dex.htm (alleging human rights violations associated with Dabhol project in India spon- sored by Enron). 7. See HubCo v. WAPDA, supra note 2 (upholding lower court injunction on public policy grounds); Patuha-ROI Interim Award, supra note 1, at B-1 1-12 (describing anti- arbitration injunction issued by Central Jakarta District Court). A similar injunction was sought, but never granted, in litigation about the Dabhol project in India. See Dabhol, Fight Goes to Court, INT'L GAS RFP., Sept. 15, 1995. 8. See Himpurna CaliforniaE nergy Ltd. v. PT (Persero)P erusahaanL istruik Negara, 14 MEALEY'S INT'L ARB. REP. A-1, A-57 (1999) [hereinafter Himpurna-PLN Final Award] (awarding US$391,711,652 to Himpurna California Energy Ltd.); Patuha-PLN Final Award, supra note 2, at B-48 (awarding US$180,570,322 to Patuha). Himpurna and Patuha were sister Indonesian geothermal power projects, each developed by Mid- American Energy Holdings Co. (formerly CalEnergy). 2001] PROJECTF INANCE & ARBITRATION 1125 electric utility, the Pakistan Water and Power Development Au- thority ("WAPDA"). Common to both sets of disputes were se- vere foreign exchange crises in the host country, allegations of corruption in obtaining the power contracts, and national politi- cal instability. The aggressive involvement of local courts in the CalEnergy and HubCo arbitration proceedings does not reassure investors relying on the perceived neutrality of international arbitral insti- tutions to mitigate the risk of uncertain justice in unstable coun- tries. The results of these arbitrations must give one pause. Are problems between State entities in troubled developing coun- tries and international project sponsors simply not arbitrable as a practical matter when economic and political crisis intersect a highly corrupt economy? Or, are there means of protecting the arbitrability of investor-State disputes in the midst of such tur- moil? The Indonesian and Pakistani controversies offer an oppor- tunity to consider these issues, but the picture is not comforting. The local courts in both countries appeared intent on prevent- ing arbitral enforcement of these high-profile public contracts. Broadly accepted judicial doctrines protecting international ar- bitration from judicial interference were ignored. The ability of the host State to take unilateral action in the midst of crisis was protected. Clear contractual language was given short shrift. Opposition to the right of foreign investors to employ arbitra- tion was not limited to cases involving the State; local courts ob- structed arbitration even in transactions solely between private parties. Conversely, the contractual and financial devices em- ployed by international investors to force resolution of difficult disputes into independent arbitral proceedings had ultimate utility only if a valuable asset (political risk insurance) existed outside the reach of the host State. Perhaps this result is not very surprising; independent power projects in both countries were large, politically visible programs that had attracted signifi- cant local opposition even before the economic crisis hit Asia. Corruption in each country has been pervasive and allegedly reached the highest levels. Foreign investors were often re- sented by local interests. Notwithstanding rapid economic growth in the 1980s and 1990s, Indonesia and Pakistan are weak States with a history of instability and unreliable political and ju- dicial systems. Moreover, the project contracts in question allo- 1126 FORDHAMINTERNATIONALLAWJOURNAL [Vol. 24:1122 cated to these weak States the financial consequences of macroeconomic changes like a currency crisis no matter how dif- ficult to absorb. In an effort to evaluate the limits of effective arbitration, I will review the events surrounding these recent arbitrations. That review leads me to conclude that few devices will be effec- tive to overcome these hurdles. Thus, arbitration may in reality be a fiction in such circumstances upon which investors should not rely exclusively. Let us turn first to the Indonesian cases. Professor Priyatna was the unfortunate GOI-appointed arbi- trator in one of two arbitrations involving the geothermal power projects in Indonesia sponsored by CalEnergy. In December 1994, PLN and Perusahaan Pertambangan Minyak Dan Gas Bumi Negara ("Pertamina"), the State-owned petroleum com- pany, entered into Energy Sales Contracts ("ESC") with special- purpose project companies established as subsidiaries of CalEnergy, respectively Himpurna California Energy Ltd. (Ber- muda) ("Himpurna") and Patuha Power Ltd. (Bermuda) ("Patuha").9 Under the Himpurna ESC, Himpurna agreed as contractor' to develop a multi-unit power project at the Dieng geothermal field on Java. PLN in turn committed to pay a U.S. Dollar-denominated tariff for available electricity from that pro- ject for a period of thirty years. Similarly, Patuha agreed under the Patuha ESC as contractor to develop a generating facility at the Patuha geothermal field, also in Java, with PLN again agree- ing to pay a U.S. Dollar tariff for a thirty-year period. At the same time, Pertamina and the respective project company en- tered into ajoint Operation Contract ('JOC") relating to opera- tion of the geothermal field that would be the source of underly- ing energy. Each ESC andJOC was also "approved... on behalf of the Government of the Republic of Indonesia" by the Indone- sian Minister of Mines and Energy, by signature at the end of the 9. See Patuha-PLNFinalAwards, upra note 2, at B-2. The following summary of facts is taken largely from the Patuha-PLNF inalA ward and from the author's personal knowl- edge of development and financing of Indonesian private power projects (and contains only information publicly available). 10. The characterization of the project company as "contractor," rather than .owner," was necessary to comply with Indonesian requirements for development of geothermal resources in cooperation with Pertamina. 2001] PROJECTF INANCE & ARBITRATION 1127 documents."' Moreover, the Indonesian Ministry of Finance is- sued letters (each, an "MoF Letter") to each project company undertaking that "[a] s long as the [project company's] material obligations which are due under the ESC and JOC have been fulfilled, the Government of the Republic of Indonesia will cause Pertamina and PLN, their successors and assigns, to honor and perform their obligations as due in the above-mentioned con- tracts." The ESCs, JOCs, and MoF Letters in the two transactions were substantially identical, except as required by the identity of the project company and physical differences between the two power projects.12 Each ESC, JOC, and MoF Letter contained a provision under which disputes relating to the relevant docu- ment would be settled by arbitration in Jakarta, Indonesia, under United Nations Commission on International Trade Law ("UN- CITRAL") rules. 3 11. See Patuha-PLNF inal Award, supra note 2, at B-2. In the early 1990s, the Minis- ter of Mines and Energy had executed Energy Sales Contracts ("ESCs" or "ESC") and Joint Operation Contracts ('3OCs" or "'OC")fo r geothermal private power projects by signing under the word "guaranteed." However, at about the time that Mines and En- ergy, PLN, and Pertamina were finalizing project documents for a number of geother- mal power projects, the Republic of Indonesia ("Republic" or "GOI") and PLN were negotiating project documents for a number of non-geothermal power projects under a general framework for private power projects. Id. at B-19-21. The general framework did not authorize the issuance of Government guarantees of the obligations of PLN under power purchase agreements. Instead, the practice developed of having the Indo- nesian Ministry of Finance issue letters of support substantially in the form discussed infra in the text. Consistent with this approach, the Ministry of Mines and Energy re- placed the word "guaranteed" with "approved" for its signature on project documents for geothermal power projects, and the GOI issued letters of support for the geother- mal projects as well. 12. Compare text of the Indonesian Ministry of Finance issued letter ("MoF Let- ter"), quoted in PatuhaP ower Ltd. (Bermuda) v. Republic of Indonesia (Final Award, October 16, 1999), 15 MEALY'S INT'L AR. REP. B-1 (2000) [hereinafter Patuha-ROIFinaAl ward], with text of MoF Letter, quoted in Himpurna CaliforniaE nergy Ltd. (Bermuda) v. Republic of Indonesia (Final Award, Oct. 16, 1999), 15 MEALEY'S INT'L ARB. REp. A-i (2000) [herein- after Himpurna-ROI Final Award]. The operative language in support letters from the MoF in other independent power projects was slightly different: "[T]he Government of the Republic of Indonesia will cause PLN, its successors and permitted assigns, to dis- charge PLN's payment obligations under the [power purchase agreement] which are due and payable and unsatisfied by PLN." See, e.g., AAP NEWSFEED, RELATING TO EEC, Sept. 2, 1998 (quoting MoF Letter relating to PT Energi Senkang power project); see also Patuha-ROIFinalA ward, supra at B-12-13 (discussing differences between phrase "to honor and perform their obligations as due" found in MoF Letters and phrase "to cause PLN ... to discharge PLN's payment obligations under the PPA"); see id. at B-14-15 (discussing restriction on guarantees). 13. See, e.g., Patuha-PLNF inal Award, supra note 2, at B-4-5 (an example of the arbitration provisions in an ESC). The arbitration provisions in the Himpurna ESC 1128 FORDHAMINTERNATIONALLAWJOURNAL [Vol. 24:1122 The actual formulation of the scope of authority of the arbi- tral tribunals differed as between the ESCs and the MoF Letters. Section 8.2 of the ESCs provided the following: Disputes, if any, arising between PLN on the one hand, and PERTAMINA and/or COMPANY on the other hand, relating to this Contract or the interpretation and performance of any of the provisions of this Contract ...s hall be referred to and finally resolved by binding arbitration as set forth in Section 8.3 below.14 Section 8.3 of each ESC then further provided that disputes were to be settled by a three-member arbitral panel under UNCI- TRAL arbitration rules. The Secretary General of the Interna- tional Center for Settlement of Investment Disputes ("ICSID") was designated as appointing authority and Jakarta was specified as the site of arbitration. Moreover, under Section 8.4 of the ESCs, the parties renounced statutory rights under the Indone- sian Code of Civil Procedure and applicable Indonesian law and regulation to appeal the decisions of the Arbitral Tribunal ("Tri- bunal"), and agreed to not seek judicial intervention in the arbi- tral proceedings. In addition, the parties agreed that: [N] o Party shall have any right to commence or maintain any suit or legal proceeding concerning a dispute hereunder un- til the dispute has been determined in accordance with the arbitration procedure provided for herein and then only for enforcement of the award rendered in such arbitration.15 The arbitration provision of the MoF Letters was simpler, but nevertheless was equally exhaustive. "Any dispute or claim arising out of or relating to this letter shall be settled by arbitra- tion under UNCITRAL Arbitration Rules in effect at the time of the arbitration, in Jakarta and otherwise in accordance with the procedural provisions set forth in Section 8.3 of the ESC.'1 6 Ac- cordingly, the parties in the Himpurna and Patuha projects were were identical. As the project documents were virtually identical for the two transac- tions, the reader should hereafter presume identical provisions unless otherwise noted. Equally, since the arbitrators were identical and the text of the decisions were virtually identical (except as required by technical project differences or the stage of project development), where the Patuha and Himpurna awards cover the same ground in a substantively identical manner, in the interest of convenience I will cite only to the Patuha award. 14. Patuha-PLNF inal Award, supra note 2, at B-4. 15. Id. 16. Patuha-ROI Final Award, supra note 12, at B-1. 2001] PROJECTF INANCE & ARBITRATION 1129 diligent in their efforts to establish arbitration as the sole forum for resolution of disputes relating to the ESCs and MoF Letters, to the exclusion of national courts save only for actions to en- force any eventual arbitration awards. Perhaps counsel for the project companies left the negotiating table well satisfied by these provisions, but later events, would demonstrate that even the best-drafted clauses can simply be ignored by local courts. The ESCs provided for Indonesian law as the governing law.17 However, the parties to the ESC also agreed upon the fol- lowing: [T]he Tribunal need not be bound to strict rules of law where they consider the application thereof to particular mat- ters to be inconsistent with the spirit of this Contract and the underlying intent of the Parties and as to such matters their conclusion shall reflect their judgment of the correct inter- pretation of all relevant terms hereof and the correct and just enforcement of this agreement in accordance with such 18 terms. The MoF Letters contained no explicit governing law clause, but did as noted above make reference to the "procedu- ral provisions set forth in Section 8.3." Nothing in the MoF Let- ters makes clear whether Section 8.3's instruction to follow the spirit of the ESCs and the intent of the parties is "procedural" and thereby incorporated into the MoF Letters. Once the project documents were put in place by the par- ties, the two project companies raised limited recourse finance on the strength of, inter alia, the contractual commitments by PLN, Pertamina, and the Government of Indonesia. As is cus- tomary for project financings, the rights of the project compa- nies under those commitments were assigned to the project lenders as collateral security.19 Financial closings for the project financings occurred in 1996 and 1997, and each project com- pany commenced drilling, procurement, and construction activi- ties upon the occurrence of the related closing.2 Those ordi- nary activities were, however, soon overtaken by extraordinary events in Indonesian and throughout the region. 17. See Patuha-PLNF inal Award, supra note 2, at B-1I (quoting Section 12 of ESC). 18. See id. (quoting Section 8.3 of ESC). 19. Patuha-ROI Final Award, supra note 12, at B-17. 20. See CalEnergy Commences Constructiono f Dieng 2 Geothermal Project in Indonesia, PR NEWSWIRE, Nov. 18, 1997.