The deep seabed mining (DSM) industry is growing rapidly, expanding beyond national jurisdiction and onto the high seas. The legal framework within which the DSM industry operates is unique and continues to evolve. While DSM has the potential to deliver great rewards to businesses and states, it also raises certain risks. The operational and technical risks of DSM are well documented.

Background

The potential for DSM has been a talking point since the 1960s and is fast approaching realisation with private contractors expecting to commence exploitation in late 2019. Presently, 29 prospecting and exploration permits have been issued to private contractors for DSM of polymetallic sulphides, polymetallic nodules and cobalt-rich crusts in waters outside national jurisdiction.

The regulation of DSM outside national jurisdictions falls under the United Nation Convention on the Law of the Sea (UNCLOS), which provides that the seabed, ocean floor and subsoil beyond the limits of national jurisdiction (the area) and its resources are the common heritage of humanity. UNCLOS also established the International Seabed Authority (ISA) as the regulator to organise and control DSM activities in the area. UNCLOS is complemented by a myriad of other instruments, including the Regulations for Prospecting and Exploration of Polymetallic Sulphides, Polymetallic Nodules and Cobalt-rich Crusts in the Area (Prospecting and Exploration Regulations). While to date there are no regulations relating to exploitation, in August 2018 the ISA released revised draft exploitation regulations with a view to finalising the exploitation regulations by mid-2019. The entire set of regulations and instruments governing DSM is referred to as the Mining Code.

For contractors considering prospecting, exploration and exploiting resources in the area, the Mining Code requires that they first obtain sponsorship from a state party to UNCLOS. This step raises several legal questions for both states and contractors, including the following:

  • How can a contractor obtain sponsorship?
  • What happens if a state revokes sponsorship?
  • What international dispute resolution mechanisms exist to protect the contractor's investment in the area?

Requirements for sponsoring states

The Mining Code requires that contractors that wish to explore, prospect or exploit resources in the area obtain a certificate of sponsorship from a state party. The contractor must obtain a certificate of sponsorship issued by the state of which it is a national or by whose nationals it is effectively controlled. A certificate of sponsorship is a document issued by the sponsoring state under the sponsoring state's national legislation.

The responsibilities of a state when sponsoring a contractor were explained in an advisory opinion from the Seabed Disputes Chamber (part of the International Tribunal for the Law of the Sea) and included as follows:

  • Sponsoring states have an obligation of due diligence to ensure compliance by contractors with the terms of the contract and the obligations set out in the Mining Code.
  • Sponsoring states have direct obligations under the Mining Code which apply independently of any relationship with a contractor. For example, sponsoring states have direct obligations to assist the ISA and to pay compensation.
  • Sponsoring states will be liable if they fail to carry out their responsibilities under UNCLOS and damage to the marine environment occurs. However, states will be absolved from liability if they have taken "all necessary and appropriate measures to secure effective compliance" by the contractor with its obligations.
  • The rules on liability under the Mining Code do not exclude customary international law. For example, a state may be liable under customary international law even though no damage has occurred.
  • UNCLOS requires sponsoring states to adopt within their legal systems laws, regulations and administrative measures that ensure the sponsored contractor complies with its obligations.

The standard of due diligence may vary over time and depends on the level of risk and activities involved. Therefore, sponsoring states may be obliged to exercise more due diligence when the contractor is undertaking more risky exploitation activities. The due diligence obligation also requires sponsoring states to adopt national laws, regulations and administrative measures that are reasonably appropriate to give effect to the requirements under the Mining Code.

This obligation to adopt national laws, regulations and administrative measures includes, but is not limited to:

  • the establishment of enforcement mechanisms for supervising contractors;
  • measures for assessing the financial viability and technical capacity of contractors; and
  • conditions for issuing certificates of sponsorship and penalties for non-compliance.

To date, several states have enacted national legislation.

How to obtain sponsorship

Contractors seeking sponsorship must be aware of their obligations under both the Mining Code and the national legislation of the sponsoring state. This is not only important to ensure compliance, but also to obtain sponsorship in the first place.

Contractors must fulfil stringent environmental obligations, such as conducting environmental impact assessments, as well as technical and financial obligations. For example, an application for approval of a plan of work for exploration will meet the financial and technical qualifications necessary:

if the sponsoring State or States certify that the applicant has expended an amount equivalent to at least 30 million United States dollars in research and exploration activities… in the location, survey and evaluation of the area referred to in the plan of work for exploration.

Further, an application must include a statement by the sponsoring state certifying that the contractor has "the necessary financial resources to meet the estimated costs of the proposed plan of work for exploration".

Contractors seeking sponsorship should also be aware of a unique requirement under the Mining Code, known as the 'parallel system'. This system requires that:

  • each application should cover a total area, which need not be a single continuous area, sufficiently large and of sufficient estimated commercial value to allow two mining operations;
  • the applicant must indicate the coordinates dividing the area into two parts of equal estimated commercial value and submit all of the data obtained by them with respect to both parts;
  • within 45 days of receiving such data, the ISA will designate which part is to be reserved solely for the conduct of activities by a developing state; and
  • the area designated must become a reserved area as soon as the plan of work for the non-reserved area is approved and the contract is signed.

The objective of the parallel system is to promote economic development by requiring that contractors share the proceeds of exploitation of the area with developing states. As set out in Article 9(4) of UNCLOS, any developing state party – or any natural or juridical person sponsored and 'effectively controlled' by a developing state party – may notify the ISA that it wishes to submit a plan of work with respect to a reserved area.

The parallel system also offers a clear incentive for contractors to partner with developing states to access reserved areas with proven commercial value. Contractors that wish to do so must ensure that they are under the effective control of a developing state. The expression 'effective control' is not defined in the Mining Code. However, in its 2014 analysis of Regulation 11.2 of the Regulations on Prospecting and Exploration for Polymetallic Nodules and Polymetallic Sulphides in the Area, the Legal and Technical Commission (an organ of the ISA) suggested that incorporating an entity in the developing state, combined with the obligation to comply with the developing state's national laws, is sufficient to establish effective control. At least one contractor has proceeded in this manner and successfully tendered for exploration of a reserved area.

Disputes

The sponsorship model poses two important questions for a contractor considering prospecting, exploration or exploitation in the area:

  • how to reduce sovereign risk to a level that makes it possible to obtain project finance; and
  • how to protect the DSM investment in circumstances where the sponsoring state may revoke the sponsorship certificate or change its laws in a way that adversely affects the contractor's investment.

As in mining projects generally, a financier considering backing a DSM project will need comfort regarding the political risk profile of the project. The financier will usually impose certain conditions precedent that require the borrower to put in place contractual clauses and investment structures that mitigate the project's sovereign risk. One such condition is that the borrower acquire the right to refer any disputes with the host state to international arbitration. In the DSM context, the Mining Code provides no international dispute resolution mechanism for disputes regarding sponsorship certificates, or any rights granted by the state to the contractor under the state's national legislative framework.

To reduce sovereign risk and to best protect their DSM investment, contractors should consider nationality planning to secure the coverage of free trade agreements (FTAs) and bilateral investment treaties (BITs) that provide protections against unlawful expropriation and unfair treatment and for investment disputes between investors and states to be resolved by arbitration. This nationality planning exercise should be undertaken before the DSM investment is made. In addition to nationality planning, contractors may also seek to obtain investment protections (including the right to refer disputes to international arbitration) through an investment agreement with their sponsoring state. In negotiating such agreements, contractors should look to secure other terms commonly included in investment agreements for major natural resources projects, such as stabilisation provisions and waivers of sovereign immunity.

Contractor should also be aware that, in some countries, international arbitration rights may be available through the national legislation of the sponsoring state. For example, Tuvalu's national DSM implementation legislation (the Seabed Minerals Act 2014) provides for any dispute between Tuvalu and a title holder to be resolved by arbitration at the International Centre for Settlement of Investment Disputes in Washington DC. Article 126(2)(b) of the Seabed Minerals Act 2014 provides as follows:

Any dispute between Tuvalu and a Title Holder arising in connection with the administration of this Act shall be dealt with by… by referral to arbitration to be conducted by arbitration by the International Centre for Settlement of Investment Disputes established under Convention on the Settlement of Investment Disputes between States and Nationals of other States or by Arbitration court proceedings as provided under the Arbitration Act.

As the exploitation phase of DSM approaches, more states (developing states in particular) will participate in the system. To attract contractors, it is likely that more states will follow the approach of Tuvalu and adopt or amend their national implementation legislation to give contractors international arbitration rights. This process of legislative competition may well include countries not ordinarily associated with oceanic affairs. There is no proximity requirement under the Mining Code to take advantage of a reserved area; thus, landlocked states are just as entitled to take advantage of the parallel regime as archipelagic states. Therefore, contractors will have increased choice in the partnership process and, in the targeting of reserved areas, will look to developing states that offer low sovereign risk and the right to international arbitration when considering potential sponsorship opportunities in this emerging market. It is also possible that an international arbitration mechanism will be included in the draft exploitation regulations, which are still under review.

Comment

As demand for minerals and metals continues to increase, contractors and states are eagerly awaiting the exploitation phase of DSM. The opportunities in this territory – much of it literally uncharted – are hard to overstate. However, with a new and evolving legal regime comes special risks. Contractors must consider the legal framework in which they are investing and seeking sponsorship. While securing project finance for DSM projects is already challenging for technical and operational reasons, sovereign risk is another major factor. Contractors should use the BIT and FTA system to secure investment protection (including international arbitration rights) wherever possible and negotiate directly with their sponsoring state for the inclusion of such protections in a sponsoring state investment agreement. As more states join in the DSM system, and competition among states increases, such rights are likely to become more widely available, including through national implementing legislation.

For further information on this topic please contact Ben Luscombe or Sam Luttrell at Clifford Chance LLP's Perth office by telephone (+61 8 9262 5555) or email (ben.luscombe@cliffordchance.com or sam.luttrell@cliffordchance.com). Alternatively, contact Audley Sheppard or James Pay at Clifford Chance LLP's London office by telephone (+44 20 7006 1000) or email (audley.sheppard@cliffordchance.com or james.pay@cliffordchance.com). The Clifford Chance website can be accessed at www.cliffordchance.com.

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