Putting the toothpaste back in the tube and other problems of longterm gas pricing contracts - News - Arbitration News Features and Reviews - Global

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Putting the toothpaste back in the tube and other
problems of longterm gas pricing contracts
Clemmie Spalton • Wednesday, 25 February 2015 (Yesterday)
Speakers at GAR Live Paris discussed the problems associated with long term gas pricing contracts and
lessons they have learnt on how to best adjust them to new market conditions.
As US baseball player Yogi Berra once said: “The future ain’t what it used to be.”
The US Secretary for Defence Donald Rumsfeld had a similar message when he
famously told a US Department of Defence press briefing: “[T]here are known
knowns; there are things we know we know. We also know there are known
unknowns; that is to say, we know there are some things we do not know. But
there are also unknown unknowns – the ones we don't know we don't know.”
These quotes aptly sum up the main problems arising from long term contracts in
the energy market or any other sphere of economic activity said Michael
Polkinghorne, a partner at White & Case in Paris, moderating the first session of GAR
Live Paris late last year.
The problem is that, since such contracts were negotiated – many of them more
than 20 years ago – market conditions have understandably changed, as has our
notion of what the coming years might bring, he explained. When negotiating long
term contracts, we thus have to guard not just against the “known unknowns” but
also the “unknown unknowns”.
It’s small wonder, in light of this, that UNIDROIT (the International Institute for the
Unification of Private Law) has set up a working group specifically to look at the
problems associated with long term contracts.
To bifurcate or not to bifurcate
The first question considered by the panel was whether bifurcation has a useful

role in gas or liquefied natural gas pricing disputes to decide preliminary
questions that will have a substantial bearing on the subsequent direction of the
case and the tribunal's ability to come up with pricing solutions.
Swiss practitioner Wolfgang Peter of Python & Peter in Geneva noted the “untypical”
nature of such disputes. One doesn’t simply have to consider whether there has
been a breach of contract but to interpret the language of the contract to see
whether a price revision is justified, in light of complex accounting and technical
information, he said.
In view of this, bifurcation is often a useful mechanism, he argued. It enables the
tribunal to consider first whether the trigger event that gives rise to a price review
exists, and to issue an interim award on that basis, before moving on to the more
technical question of how to reformulate the prices.
Peter added that the price reformulation is often the most difficult part for
arbitrators, who aren’t experts in the economics of the energy industry.
Marco Lorefice, a senior lawyer at Italian energy utility Edison who has been working
on several price review cases, agreed that bifurcation has the potential to be
useful, depending on the circumstances, but warned that it may be sought
abusively.
Sometimes, a respondent requests bifurcation as a delay tactic – to postpone the
tribunal’s final decision, thereby putting pressure on the claimant to settle, he
said.
Negotiating in good faith
Most gas contracts mandate a period, frequently six months, of good faith
negotiations before parties can submit their pricing dispute to arbitration. But
Peter said the requirement can be problematic.
He had seen cases where one party either refuses to agree to the confidentiality
of the negotiation (which means that information disclosed by either side can be
used in a subsequent arbitration) or disagrees with the position of the other party
but refuses to put forward a counterargument. In such cases negotiations are
useless, he said.
Patrick Hébréard, a negotiator at BP, added that he had experienced cases where
the whole negotiation period is spent discussing whether the price review trigger
has arisen rather than the issue of pricing itself.
Dan Harris of Brattle Group, a consulting services and expert testimony provider,
had experienced cases where parties refuse to participate in negotiations all
together let alone make affirmative arguments, claiming to be “too busy”.
The problem is that parties often view negotiation periods as “waiting periods”,

Polkinghorne said. He recommended that those entering contracts include
clauses to ensure the negotiations will take place and have real effect, for
example, specifying that the parties meet within a month of the dispute arising.
The reluctance of one side to engage can continue even after the negotiation
period has finished and a tribunal has been formed. Peter said that one way to
make a recalcitrant party participate in the arbitral process is for the other side
start paying a “provisional price” based on what they think they should pay, rather
than the amount specified in the contract, pending the outcome of the case.
This will encourage the other party to engage with the tribunal, as it will want to
request interim measures to ensure payments continue at the contractual price,
he said.
War’s war
Next, panelists considered the question already touched upon of how different
parties view the confidentiality of mandatory prearbitration negotiations. For
some, any agreement reached is akin to a settlement and should not be revealed
to the tribunal. Others see things differently.
Polkinghorne asked panelists if they had experienced cases where one party
breached confidentiality by producing information from the “confidential”
negotiations – for example the fact that one party had been willing to accept a
lower price – before the arbitral tribunal.
They had. Indeed, one speaker from the floor, Philippe Pinsolle of Quinn Emanuel
Urquhart & Sullivan even recalled a case where one side had included a whole
bundle of “without prejudice” material exchanged during negotiations in its
request for arbitration – and the tribunal had admitted it.
For Lorefice such behaviour is inevitable. “As they say in French, à la guerre comme à
la guerre [war’s war].”
He continued that he would expect a tribunal to ostensibly exclude such evidence
while in reality allowing it to impact on their decision.
Peter disagreed, arguing that tribunals should and would take a dim view of such
revelations.
Harris pointed out the difficulty of disregarding information once it has been
brought into the open – particularly if the difference between the party’s
negotiating position and stance in the arbitration is a startling one. For example,
he’d come across situations where a party has sought a 15 per cent price
decrease in an arbitration when it was prepared to accept a 10 per cent increase
in negotiations. How could a tribunal just disregard that information, he wanted to
know.

Polkinghorne put it more pithily: “How do you put the toothpaste back in the
tube?”
In his view, confidentiality as it relates to long term contracts risks being “a
complete mess”.
Different types of getout clauses
In addition to price review clauses, parties may rely on force majeure clauses to
enable them to renegotiate terms during the life of the contract.
They can also rely on the principle of hardship found in some national laws or
written into the contract, which allows a party to renegotiate contractual terms
where continued performance of the contract has become excessively
burdensome due to an event beyond its reasonable control.
One audience member, Eckart Brödermann of Brödermann Jahn in Hamburg, even
recalled a gas pricing contract relating to North Africa where the principle of
hardship had been incorporated into the force majeure clause.
Thinking on the drafting of such clauses has naturally developed over time.
Twenty years ago price review clauses had little to say on what constituted a
trigger for a price review, said Hébréard. But since the financial crisis of 2008
gave rise to a significant number of arbitrations, negotiators want this to be laid
out as clearly as possible, in anticipation that one side will want to reopen the
question of pricing at some point.
In particular they want to avoid vague or openended drafting, which can be the
subject of debate.
Force majeure clauses are still harder to draft as you are providing for
“unknowns”, he said. But he added that most gas sellers would prefer carefully
drafted provisions rather than simply to rely on the legal principle of “hardship”
with all the uncertainties that entails.
The hardship of establishing hardship
Lorefice talked about the principle of “hardship” in more detail and the differing
approaches taken in domestic legislation around the world, highlighting some of
the remedies available to a victim of hardship.
Article 107 of the Algerian civil code, for example, gives the party affected by
hardship the right to request the amendment of all contractual terms not just the
price, while article 1467 of the Italian civil code gives them the right to withdraw
from the contract if it is not modified.
But for hardship to be established, the trigger event has to be unforeseeable at
the date of entering the contract, he explained. When parties to a contract
foresee that there may be events that will affect the price of the contract, and

acknowledge as such through a price review clause, hardship cannot be relied
on.
Parties to gas pricing contracts generally forfeit the chance of establishing
hardship, with its high threshold, in favour of price review clauses that do not
require unforseeability and are therefore easier to trigger, he said.
But the remedies available through a price review are less generous: merely
modification of the price rather than a review of the whole contract or the
possibility of withdrawing all together.
Peter agreed that price review is the only real solution under long term contracts,
describing it as a kind of “security valve” by which the parties can adjust the
contract without meeting the high demands of establishing hardship.
That said, he thought that a party who can prove it is not just seeking a price
review out of contractual entitlement and has been put in a situation of real
financial hardship because of the contract might persuade a tribunal to order a
larger price adjustment than would have been permitted otherwise.
Take or pay
Polkinghorne asked the panelists for their experience of “take or pay clauses” –
which oblige a buyer to pay for gas even when not taken (subject, often, to the
condition that they are able to do so later). Unlike the general price requirements,
such take or pay obligations may not be reviewable under the contract.
In that situation, must the buyer establish hardship to reduce the volume of gas
he must take before the penalty is payable? Or does it all depend on how the
contract is drafted?
Peter thought it was seldom necessary to establish hardship in htis cricumstance.
He said he had seen tribunals address take or pay clauses as part of a price
review as a substitute for price adjustment. It’s really a question of whether the
arbitrators believe it falls within their jurisdiction, he said. In his experience, they
do.
The EU element
In a discussion on some of the creative arguments employed by counsel related
to take or pay clauses and other pricing obligations under long term offtake
agreements, Colin Graham, a partner at Orrick Herrington & Sutcliffe in London,
raised the question of whether parties are showing a tendency to raise arguments
based on European Union competition law policy to influence gas or liquefied
natural gas pricing arbitrations.
Although there are few formal decisions, there have been a number of policy
statements made by European Commission officials that have suggested it is

moving towards taking a stronger line on pricing provisions in such agreements
that could affect competition in the EU gas market.
As a result, a party might raise arguments in a price revision arbitration that it
cannot agree to a revised price formula because it would constitute illegal profit
splitting or usebased pricing.
Equally, a stateowned gas buyer might raise arguments that to accept an
upward price revision, in an agreement that it may have since decided was to its
commercial detriment, would amount to illegal state aid.
The Russian gas producer Gazprom is currently facing an EU investigation into
whether it abused its dominance to block rivals and squeeze out alternative
sources of gas supply and the outcome of that might shed some light on the limits
to such arguments, Graham said.
This could pave the way for parties to gas pricing arbitrations to adduce external
expert opinions or consultations which might, even contrary to the expert opinion
on pricing, lead the case in an new direction.
Peter also thought there was enormous potential for long term gas pricing
contracts to fall foul of EU competition law because of their duration. He recalled
one case in which a seller in a strong position agreed to reduce the volume of
gas provided to the buyer on the basis that they would keep purchasing at the
end of the contract until the volume had been taken – potentially transforming it
into an illegal neverending contract.
And Harris admitted consideration of abuse of dominance arguments against a
seller in a case in which an enormous drop in demand in a gas buyer's country
meant they were unable to take the volume of gas required under the contract
even with a very significant price revision.
Is there another way?
Panelists considered whether arbitrators are best equipped to revise the price of
contracts or it would be better done by mediators or gas pricing experts?
Hébréard thought that arbitration by a threestrong tribunal of lawyers is the right
mechanism in light of the complexity of the law surrounding this area and the vast
amounts in dispute. It would be too much to leave the job to a single expert, he
said
As for mediation, he said he had never come across it in this context. “Why would
parties use mediation, when they can just negotiate among themselves?” he said.
However, one audience member highlighted how the length of arbitration can be
a problem as the market can change significantly during the case. As a result, the
data and knowledge available to the tribunal when it has to issue its decision is

different from that available to the parties when they began their negotiations on
the price.
When this happens, the tribunal has the choice of either rendering a decision
which is technically within the correct data reference period, but which is by now
completely out of date, or a decision that is in line with the current market but out
of step with why the arbitration was brought in the first place, she said.
If they opt for the first choice, the result may be that the parties will have to
immediately recommence price revision negotiations after the arbitration is
complete.
Lorefice said that in his view, the decision of the tribunal should be a “forward
looking exercise” based on as much information as possible, including data that
emerged since the price revision negotiations began. However, he acknowledged
that limits needs to be set in an arbitration – proposing that the tribunal should be
able to consider data that emerged within 12 months of the request for a price
review.
The tribunal's aim should be to come up with a new price that will be sustainable
in accordance with the terms of the contract at least up to the next review date
agreed by the parties, he said.
Restoring the balance
Finally, the panelists discussed what Peter described as “the extremely difficult
task for arbitrators of restoring the economic balance of the contract through their
price formulations."
Assuming that “restoring the balance” simply means getting the parties back to
the bargain they agreed at the start of the contract is too simplistic he said. You
cannot have a “one size fits all rule”.
Harris added that restoring balance should not necessarily mean putting the
parties in a position where they are both benefitting from the contract
economically, as this does not take into account the risk one or the other may
have taken in entering the contract.
He said he had seen cases where, having taken a deliberate risk, a party who
had not benefitted as they hoped from the deal sought a price review in hope of
making it profitable. To change the price formula in these cases is really
interfering with the parties’ original bargain, he argued.
The reason the task of reformulating price is so tricky is that the arbitrators must
imagine the knowledge and attitude of the parties at the time they signed the
contract.
Hébréard added that, in his experience, the most argued defence by sellers is

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that they should not have to take on responsibility and liability for a buyer’s
marketing inefficiency.
GAR Live Paris took place on 14 November 2014 at the offices of Orrick Herrington & Sutcliffe in the 16th
arrondissment.
The next GAR Live will take place in Sao Paulo on 19 March. Later events will take place in Washington, DC
(27 April), London (6 and 7 May), Frankfurt (3 June), Singapore (15 June), Istanbul (25 June), New York (24
September), Hong Kong (22 October), Dubai (19 November) and Paris (20 November). The event in London on 6
May is devoted to energy arbitration and will be chaired by Michael Polkinghorne.

Putting the toothpaste back in the tube and other problems of longterm gas pricing contracts - News - Arbitration News Features and Reviews - Global

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Putting the toothpaste back in the tube and other problems of longterm gas pricing contracts - News - Arbitration News Features and Reviews - Global