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05 March 2018
In Monde Petroleum SA v Westernzagros Ltd  EWCA Civ 25, the Court of Appeal has provided guidance as to what the words "fully operational and enforceable" in an agreement might mean in the context of a production sharing agreement in Kurdistan (Iraq). In particular, whether such an agreement may be considered fully operational and enforceable without ratification by the Federal Government of Iraq. In doing so, the Court of Appeal ventured into an area that is hotly contested in Iraq.
As we set out in our coverage of the Commercial Court's decision (see Oil & Gas Contracts: Misrepresentation in termination negotiations (August 2016)), the background facts are as follows:
In early 2006, WesternZagros Ltd ("WZL"), sought to negotiate and thereafter enter into an Exploration and Production Sharing Agreement ("PSA") with the Kurdistan Regional Government ("KRG"). Following an impasse in negotiations, WZL was directed to Mr Yasser Al-Fekaiki, sole Director of Monde Petroleum SA ("Monde"), who had family connections within the KRG, to assist in lobbying for WZL support within the KRG.
Subsequently, WZL and Monde entered into a Consultancy Services Agreement ("CSA"). The CSA allowed for monthly payments together with success fees which could be triggered by achieving 'milestones' linked to the PSA Seismic Program and ratification of the PSA (in the form of a Confirmation and Support Letter of the Government of the Republic of Iraq) ("Iraqi Federal Government"). If ratification was achieved, and subject to the milestones being reached, the PSA gave Monde the right to acquire a 3% working interest in the PSA.
The termination provisions of the CSA stated:
"10.2… this Agreement shall continue if the [PSA] is executed within 4 months from the date hereof or, if the [PSA] is not executed, at the election of [WZL], provided that this Agreement and the option contemplated in Schedule "C" (the Option) may be terminated by [WZL] upon thirty days' notice to [Monde] should the [PSA] not become fully operational and enforceable within six months from the date hereof. If this Agreement is continued as set out above, on the 1 year anniversary of this Agreement it shall terminate with respect to the payments contemplated in Schedule "B", unless mutually extended for 1 year terms.
10.3 Notwithstanding the provisions of Section 10.1 and 10.2 above, this Agreement and the Option may be terminated:
(i) by [WZL] upon thirty days' advance written notice to [Monde] if it becomes manifestly apparent that an operational and enforceable [PSA] in form and on terms acceptable to [WZL] cannot be concluded;
(ii) by either party immediately in the event the other party commits a material breach of this Agreement which remains uncured after the period for curing specified in the notice of the breach has expired;
(iii) by mutual written agreement of the parties;
(iv) by election of [WZL] on the termination of the [PSA]; or
(v) by [WZL] if it is manifestly apparent that achievement of the milestones set out in Schedule "B" are being achieved primarily as a result of activities of third parties."
The final sentence of Schedule B stated that "the Option shall only vest upon the events described in (c) above having occurred."
In May 2006, a PSA was signed between WZL and the KRG (less than 2 weeks after the execution of the Monde CSA). However, at that stage the PSA had yet to be ratified. Prior to or during the PSA negotiations, Monde (unbeknown to WZL) had formed an arrangement with Bafel Talabani ("Bafel"), son of the President of Iraq and a Commander of the KRG's Counter Terrorism Group, who had been involved in the PSA negotiations.
In March 2007, after concerns regarding performance and rumours of a 'fall from grace' in the region, WZL faxed a notice of termination to Monde ("Notice of Termination"). However, the Notice of Termination did not provide the requisite 30 day notice period in accordance with the termination provisions of the CSA. In April 2007, a draft termination agreement was sent to Monde ("Termination Agreement"). Monde refused to sign.
There was then a change in relationship between Bafel and Monde. Bafel made a series of telephone calls to Mr Al-Fekaiki (sole director of Monde). Monde argued that Bafel advised that if it signed the Termination Agreement it would benefit through a new agreement between WZL and a politically controlled entity under which Monde would receive payment indirectly and would be no worse off than if the CSA had continued. Monde also argued that Bafel promised that it would receive an immediate payment of all outstanding sums due to Monde by WZL if it signed the Termination Agreement. Four days after Monde's initial refusal, Mr Al-Fekaiki signed the Termination Agreement, on behalf of Monde.
In the Commercial Court Monde claimed that its signing of the Termination Agreement was procured by misrepresentations made by Bafel on WZL's behalf and/or economic duress. On that basis, Monde sought to set aside the Termination Agreement and/or to claim damages, and asserted that the Notice of Termination was invalid and that, by serving it, WZL committed a repudiatory breach of the CSA, entitling Monde to substantial damages for the loss of its rights under the CSA, including its 3% option.
WZL denied making any misrepresentations or exercising any duress to procure the Termination Agreement. WZL also said that, even if Monde were to succeed in its claims relating to the Termination Agreement, Monde would be unable to prove any or any substantial loss because, on WZL's case, the Termination Notice was itself effective to bring the CSA to an end, or (if that be wrong) WZL would have been entitled to serve a further such notice. In either event, no further payments would have become due to Monde under the CSA, and Monde's 3% option would never have vested.
The Commercial Court decided that the Termination Agreement had been procured by misrepresentation but that Monde could not prove any loss following from that because WZL was at all times entitled to terminate the CSA on notice thus ensuring that Monde would never have been in the position to exercise its 3% option.
Monde appealed against the decision to the Court of Appeal.
Permission to appeal was restricted to the following two issues:
The Court of Appeal unanimously upheld the Commercial Court's ruling.
In relation to the first question, the Court of Appeal decided that the phrase "fully operational and enforceable" had to have the same meaning throughout the CSA. Monde's Iraqi law expert had accepted that the KRG and the Iraqi Federal Government had differences of view as to the extent of the KRG's authority to grant exploration and production agreements in relation to Kurdistan and whether KRG was entitled or had the authority to enter into such agreements. There was also uncertainty as to whether the KRG owned the oil fields in Kurdistan at all and therefore whether the PSA had been ratified "appropriately to the acceptance of all the political players". As such the Court of Appeal found that mere ratification of the PSA by the KRG did not render the PSA "fully operational and enforceable". For that to be the case both the KRG and the Iraqi Federal Government had to be "onside".
It was entirely legitimate for the Commercial Court to accept, from the rival interpretations, the interpretation that it considered made commercial sense and was "rooted fairly and squarely, in the commercial and political background which existed at the time when the contract was made."
In response to the second question, the Court of Appeal decided that this was a "hopeless contention" and found that WZL had the right to terminate the CSA at a time of its own choosing. Clause 10.2 provided that WZL could terminate "should the [PSA] not become fully operational and enforceable within six months from the date of the [PSA]." No requirement of immediacy was expressed in the contract terms and there was no reason for such immediacy to be implied. The effect of such an argument would be that if notice was not immediately given, WZL would be locked into the CSA until such time as it could show within the terms of clause 10.3 that it had become "manifestly apparent that an operational and enforceable [PSA] ... [could not] be concluded." The Court of Appeal considered this position to be "highly un-commercial."
In Iraq, disagreements persist as to the KRG's right to award PSAs without the ratification or authority of the Iraqi Federal Government. The KRG claims competency to award oil interests. The Iraqi Federal Government considers such award to be a federal issue and within the Iraqi Federal Government competency. As such, an uneasy de facto state of affairs has come to exist whereby KRG PSAs exist and exports of oil emanating from Kurdistan continue, but without the authority of the Iraqi Federal Government. Further, oil companies that continue to own KRG PSA interests are routinely disqualified from owning oil interests in the rest of Iraq by the Iraqi Federal Government. It follows that whether KRG PSAs are "fully operational and enforceable" is a far from straightforward question. The KRG would doubtless say that its PSAs are fully operational and enforceable. The Iraqi Federal Government would not agree.
Whilst the Court of Appeal affirmed that while it will not allow commercial common sense and surrounding circumstances to be invoked to undervalue the importance of the language of the provision to be construed, it also confirmed that it would undertake a robust analysis of the circumstances to ensure that any commercial contract is construed against its commercial background. In construing a contract to be performed in Iraq, this included the political and legal background relevant to Iraq.
The Commercial Court and Court of Appeal reached the conclusion that in the CSA "fully operational and enforceable" meant that Iraqi Federal Government approval was required. However, the conclusions of the Court of Appeal are arguably specific to the facts of the CSA. The Court of Appeal did not make any decision as to the proper interpretation of the legal position in Iraq.
The Court of Appeal decision is a salutary reminder that whilst words such as "fully operational and enforceable" may be susceptible to only one interpretation in some jurisdictions, in other jurisdictions issues over competency to award/ratify or international boundaries might render such words open to multiple interpretations.
For further information on this topic please contact Phillip Ashley or Robert Wilson at CMS Cameron McKenna Nabarro Olswang LLP's London office by telephone (+44 20 7367 3000) or email (firstname.lastname@example.org or email@example.com) Alternatively, please contact Matthew Culver or Randall Walker at CMS Cameron McKenna Nabarro Olswang LLP's Dubai office by telephone (+971 4374 2805) or email (firstname.lastname@example.org or email@example.com). The CMS Cameron McKenna Nabarro Olswang LLP website can be accessed at cms.law.
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