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Risk hedging best way to go with investor State contracts

Kenya National Highways Authority director- general Peter Mundiria (left) and China State Construction Engineering Corporation Eastern African Region general manager Zhang Ruiping (right) exchange contract documents after signing an agreement for a road upgrade. FILE PHOTO | NMG
Kenya National Highways Authority director- general Peter Mundiria (left) and China State Construction Engineering Corporation Eastern African Region general manager Zhang Ruiping (right) exchange contract documents after signing an agreement for a road upgrade. FILE PHOTO | NMG 

In the last few years, Kenya has witnessed the establishment of many projects in energy and natural resources including wind, solar energy and oil projects to name a few.

Most of the time, these projects are run by the State in partnership with foreign investors who have the expertise and capital in what are commonly referred to as investor State contracts.

These contracts are unique as the State holds a monopoly over the natural resource while the investor may have a monopoly over capital and expertise. When an investor state contract is entered into there are many clauses that need to be understood by both sides to minimise on risk.

To highlight the importance of both parties being on the same page, I will use the case of WalAm Energy versus Republic of Kenya, which is a case filed in the International Centre For Settlement Of Investment Disputes based in London. This case was reported in the media as a 2017 case. The case was filed by WalAm against Kenya over the cancellation of a 30-year geothermal licence granted to the claimant and the amount at stake is Sh62 billion.

While the State went into a lot of technicalities for example citing the lack of technical capacity of the licensee to undertake the project, the claimant argued that the cancellation would lead to some losses on its part, as it had obviously invested heavily before the cancellation was made. I do not yet know the outcome of this case.

However, it goes to show the gravity of any breaches that may occur in an investor state contract. The amounts at stake are very huge.

Most investors in these type of projects properly understand the risks involved.

However, for highlighting purposes some legal risks may arise. These include the risk of changes in the law. A change in the law, may materially affect the investor in performance of a contract.

It would, however, be unreasonable for an investor to demand a State ban on legislative powers after the international standard contract (ISC) is entered into, as this would impede on the sovereignty of the State.

This is where proper drafting of ISC contracts comes in where the investor may seek a renegotiation of terms of the contract in the event of a change in law.

I believe that this may be the position if the Kenyan Petroleum Mining Bill is enacted. This bill seeks to increase the revenue sharing of the local community by significant percentages.

Assuming that at the time of signing the ISC (if at all this was signed), this law did not exist, then if it is passed it then, means the investor may be materially affected. The investor cannot stop the State from passing this law, however, it can seek a renegotiation of terms at international arbitration level.

Coupled with a risk of change in law, is the risk of change in regime. Different governments come with different policies and an incoming regime may have policies that may affect the investor.

In cases of political risk, at times an investor may face the risk of nationalism whereby the regime in place adopts a nationalistic approach towards the natural resource therefore nationalising the resource. This happened sometime back in Kuwait when the oil concession was nationalised to the detriment of the investor.

This is why it is important to hedge all risk at the negotiation stage and one way is for the dispute to be settled in a foreign jurisdiction through arbitration.

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