July 11 2016 Do administrative authorities have a termination right in gas concession agreements? Broad & Bright | Energy & Natural Resources - China Energy & Natural Resources IntroductionGas concession rightsFactsNature of agreementValidity of agreementTermination rightDecisionCommentIntroductionThe rapid development of urban infrastructure construction has seen natural gas – together with water, electricity and heating – become part of the municipal underground integrated pipeline network. Although social capital can be used to introduce gas facilities to the urban market, investors and operators are strongly supervised by the government and must acquire government concession rights to run such facilities.On April 25 2015 the National Development and Reform Commission, along with five other ministries, enacted the Administrative Measures on Government Concession Rights for Infrastructure and Public Utilities, which came into effect on June 1 2015. In its executive meeting, the State Council advised that:"Carrying out the concession for infrastructure and public utilities is an important reform and institutional innovation, it increases the supply of public goods and services; and along with policy to encourage people to start their own business and to make innovations form[s] the 'double engine' of economic development."(1)The measures encourage both domestic and foreign social capital investors and operators to enter into gas concession agreements with the relevant government body in various sectors, including energy, transportation, hydraulic engineering, environmental protection and municipal public engineering. The concession agreements can be realised under various models, such as:the build-operate-transfer model;the build-own-operate-transfer model; andthe build-transfer-operate model.The measures regulate the establishment, operation, conclusion and performance of gas concession agreements.Gas concession rightsA gas concession right is essentially an administrative licence that cannot be awarded without open competition, such as via public tendering or auction. It is an exclusive right that is beneficial to public welfare, while at the same time able to generate a profit. As gas concession agreements involve both enterprises and government bodies, the nature of such agreements implies that public and investor interests must be protected and managed equally. This is dependant on the successful performance of the agreement by both parties.Under what conditions and through what methods an administrative authority can exercise its termination right under an administrative contract are critical questions. It is important to prevent the government from arbitrarily terminating a contract while simultaneously permitting it to exercise such right in certain circumstances. In Wuhan PetroChina Kunlun Gas Co, Ltd v City Administration Committee of Jiangxia District of Wuhan – decided by the Donghu New Technology Development District Municipal People's Court in Wuhan in August 2015 – the judge supported the government's termination right as the entity granted the natural gas concession had failed to fulfil the agreement in accordance with the Contract Law.(2)FactsOn April 21 2009 the Jiangxia District People's Government of Wuhan approved and granted a natural gas concession to Wuhan PetroChina Kunlun Gas Co, Ltd. On May 25 2010 the Urban-Rural Construction Bureau of Jiangxia District was authorised by the district government to enter into a city pipeline gas operating agreement with Kunlun. The approved scope of the natural gas concession as stipulated in the agreement was 30 years. Several months later, the bureau's gas concession administration authority was shifted to the Jiangxia District of Wuhan City Administration Committee.On May 22 2014 the district government further delimited the concession scope and one of the original areas (the Jinkou area) was excluded. On July 22 2014 the committee sent a natural gas concession agreement termination notice to Kunlun on behalf of the district government. Before Kunlun received the letter, it submitted an administrative reconsideration against the committee to the People's Government of Wuhan, seeking termination of the agreement. Kunlun and the district government held a special coordination meeting on the dispute, but failed to reach a consensus. On November 12 2014 the People's Government of Wuhan rejected Kunlun's reconsideration request. Kunlun then brought a court action against the committee, requiring the district government to perform the agreement.According to the court, the case involved three major issues:the nature of the agreement;the validity of the agreement; andwhether the district government had enjoyed the termination right and exercised such right legitimately.Nature of agreementThe court noted that Article 12 of the amended Administrative Litigation Law provides that:"The people's court shall accept the following claim lodged by any citizens, legal entity or any other organizations:… (11) believing an administrative body failed to perform in accordance with the laws or the contractual agreement, or change[d] or revoke[d] illegally [a] government concession agreement, land and housing expropriation and compensation agreement or any other agreement of this kind." Article 11(1) of the Interpretations of the Supreme People's Court on Certain Issues Concerning the Application of the Administrative Litigation Law provides that:"An agreement entered into by an administrative authority, for the purpose of realization of public interests or administrative goal and to the extent of its powers and functions, with a citizen, legal entity or other organizations through consultation, shall constitute an administrative agreement as stipulated in Article 12(11) of the Administrative Litigation Law. Where a citizen, legal entity or other organizations bring an administrative lawsuit in respect of the following administrative agreement, the people's courts shall accept the case according to law: (1) government's concession agreement."In accordance with these provisions, the court reviewed the form and content of the natural gas concession agreement and found that it fell within the scope of an administrative agreement.Validity of agreementThe district government argued that the natural gas concession agreement was null and void as it had not been secured through public tender or auction, which violated the mandatory rules on effectiveness prescribed by the Administrative Licensing Law. The court found that the two parties had entered into the concession agreement by mutual consent on the basis of the Contract Law. Article 12(2) of the Administrative Licensing Law provides that an administrative licence for the development and utilisation of limited natural resources, the allocation of public resources or the market entry of special trades that directly concern public interests must be secured by such means as a bid invitation or auction. However, because the concession agreement was a type of contract actively managed by administrative bodies, the administrative counterparts to the agreement were passive receiving parties and – as such – had no right to choose the manner in which the agreement was secured.Therefore, according to the good-faith principle, the district government could not deny the validity of the agreement due to the lack of fair selection process. The provision is a mandatory rule on management, not effectiveness. The court held that the agreement was a valid contract, and that the district government's argument could not be supported.Termination rightThe court examined whether the district government had enjoyed a termination right. According to Article 94(4) of the Contract Law, if there are "legally prescribed conditions giving rise to [a] termination right the parties may terminate a contract if the other party delayed performance or otherwise breached the contract, thereby frustrating the purpose of the contract". Under the concession agreement, Kunlun had had to formulate a "long-term and short-term investment plan [for] gas pipeline development [and] organize the investment and construction in accordance with the requirements of city comprehensive planning and professional planning of gas".DecisionThe court found that Kunlun had failed to:complete the preliminary design and construction implementation plan for the Jinkou area before instituting legal proceedings; andundertake construction in accordance with the requirements of the specialised gas plan for the Jiangxia District.The facts indicated that Kunlun had been delayed in performing its obligations, which resulted in its failure to achieve the purpose of gas supply in the Jinkou area. Therefore, the district government had had the right to terminate the agreement as the legal condition of such right had been established.On both October 28 2009 and July 28 2010 the district government had urged Kunlun to fulfil its obligations, stating that if Kunlun failed to fulfil its obligations its natural gas concession right would be cancelled. These actions should be identified as the defendant having performed its notification obligation. The district government had given the plaintiff a sufficient cure period; there was a nine-month interval between the issuing of the two exigent notices and the last exigent notice was issued four years after the date on which the termination notice was delivered. During this time, Kunlun had responded to the termination notice, but had failed to rectify or eliminate the obstacles preventing it from fulfilling the concession agreement. Kunlun had also failed to raise any objection as to why it could not fulfil its obligations.The court affirmed that the district government's notices satisfied the termination by notification provision of Article 96 of the Contract Law.(3) The court ruled that Kunlun's arguments were unfounded and that since Kunlun had broken the agreement in the first place, the district government had had the right to terminate the agreement.CommentWuhan raised two controversial judicial practice issues:whether a gas concession agreement should be considered a contract between two equal persons; andwhether civil laws should be applied in disputes, or whether the entity granted such a concession right may resort only to administrative procedures.According to the Administration Litigation Law, all disputes arising from government concession agreements fall within the jurisdiction of administrative courts. As for applicable law, Article 14 of the Interpretations of the Supreme People's Court on Certain Issues Concerning the Application of the Administrative Litigation Law stipulates that civil laws should apply if they do not violate the compulsory provisions of administrative laws (including the Administration Litigation Law).(4) In Wuhan the court ruled – in accordance with the Contract Law – that the agreement was rescinded due to the breach of contract by Kunlun (the administrative counterpart).The natural gas concession right in Wuhan was not awarded in strict accordance with legal procedure, which had an adverse effect on public welfare and the interests of potential applicants. In addition, the growing use of public-private partnerships (PPPs) as a step towards marketisation is problematic – as while the application of civil and contract law to such contracts should be subject to the administrative laws (including the Administrative Litigation Law), investors' expectations and interests remain in a state of uncertainty. Wuhan failed to answer the question of whether administrative authorities can terminate contracts based unilaterally on policy changes that they themselves have made. Since administrative authorities have more advantages than administrative counterparts, if the concession agreement will be terminated in such way, the counterparts' rights and interests cannot be protected. Although China has made increasing efforts in its reform of the oil and gas industry, challenges must still be overcome before a market-based regulatory regime and a fair and competitive environment for investors and operators can be established.For further information on this topic please contact Libin Zhang or Shi Le Lin at Broad & Bright by telephone (+86 10 8513 1818) or email ([email protected] or [email protected]). The Broad & Bright website can be accessed at www.broadbright.com.Endnotes(1) Premier Li Keqiang chaired the State Council executive meeting. For further details please see www.gov.cn/guowuyuan/2015-04/21/content_2850389.htm(2) See the Municipal People's Court of Donghu New Technology Development District Civil Judgment, Wuhan, August 2015, Er-Wu-Dong-Kai-Chu-Zi No 00022 (2015).(3) See Article 96 of the Contract Law, which states that termination is subject to approval:"The party availing itself of termination of a contract in accordance with Paragraph 2 of Article 93 and Article 94 hereof shall notify the other party. The contract is terminated when the notice reaches the other party. If the other party objects to the termination, the terminating party may petition the People's Court or an arbitration institution to affirm the validity of the termination."(4) See Article 14 of the Interpretations of the Supreme People's Court on Certain Issues Concerning the Application of the Administrative Litigation Law, which states that:"When the people's court reviews whether or not an administrative authority has performed an agreement according to law or as agreed or its unilateral change or termination of agreement is legal, the court may, in addition to application of the administrative laws, apply the provisions of civil laws that are not in violation of the compulsory provisions of the administrative laws and the Administrative Litigation Law."