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November 2020: Another Victory for Brazilian Oil Company in Consortium Dispute

November 2020

The firm’s Paris and London offices recently obtained an arbitral award confirming the validity and effectiveness of a notice excluding a party from a consortium responsible for an oil project off the coast of Brazil – without compensation – on the grounds that it was in default of its obligation to contribute to consortium’s costs and expenditure. The arbitral tribunal also rejected all of the excluded party’s claims for compensation against the firm’s client, even though the excluded party argued that it was incompatible with Brazilian law for it to be excluded from the consortium and to receive no compensation even though it had allegedly contributed USD 500 million towards the project.

The firm’s client (which was a respondent in the arbitration), the excluded party (which was the claimant) and another entity (which was a co-respondent with the firm’s client) were parties to a Joint Operating Agreement following a standard industry form issued by the Association of International Petroleum Negotiators (AIPN). As is usual practice, the agreement provided that: (i) the parties were to contribute to the costs and expenditure of the consortium in proportion to their interests in the project; (ii) a party which failed to do so was in default under the agreement; and (iii) if the default was not remedied within 60 days, a non-defaulting party could issue a notice excluding the defaulting party from the project and requiring the defaulting party to transfer its interest to the non-defaulting parties at no cost. Although such provisions are found in many Joint Operating Agreements around the world, they are rarely invoked due (in part) to the uncertainty as to whether the provisions are enforceable, particularly in civil law jurisdictions.

In October 2017, the firm’s client issued a withdrawal notice excluding the claimant from the project on the basis that it was in default of payments totalling approximately USD 7 million (a relatively small amount when compared the sums generally invested in oil projects). The claimant then commenced an arbitration, alleging, among other things, that the withdrawal notice was improperly issued, and that the contractual provision pursuant to which it was issued was contrary to the Brazilian Constitution and various principles of Brazilian law and was therefore invalid. In the alternative, the claimant sought compensation for the “loss” of the investments which it had made in the project, which it said totalled USD 500 million.

In an earlier award issued in September 2018, the arbitral tribunal upheld the validity and effectiveness of the withdrawal notice issued by the firm’s client and rejected all of the claimant’s challenges to the validity of the contractual provisions pursuant to which it was issued. However, the arbitral tribunal reserved for a further hearing the question of whether, notwithstanding its validity, the withdrawal notice could subsequently be subject to nullification under Brazilian law (an outcome which is possible under many civil law jurisdictions, although generally not under common law jurisdictions).

At the further hearing, the claimant argued that the firm’s client had issued the withdrawal notice in bad faith or that its conduct in doing so amounted to an abuse of right, and that the withdrawal notice therefore should be nullified under Brazilian law or, in the alternative, that the firm’s client (and the co-respondent) should be required to pay compensation for the alleged act of bad faith or abuse of right. In an award issued in July 2020, the arbitral tribunal rejected all of the claimant’s arguments – both on the ground that the claimant’s factual case had not been made out, and in light of the expert evidence of Brazilian law scholars engaged by the firm’s client and the co-respondent, who testified that the claimant’s claims in any event had no foundation under Brazilian law, as the relevant terms of the contract meant what they said, even if this might appear to produce an unusual outcome.

The awards in this arbitration are important for the oil industry, as they will help settle the long-standing debate as to the enforceability and effect of the forfeiture clauses found in many standard form consortium agreements. The awards will also be welcomed by the industry, for which dealing with defaulting partners has become an increasing problem.