The recent unilateral action taken by the Government of Papua New Guinea (PNG) to pass legislation to effectively acquire 100% ownership of the Ok Tedi copper/gold mine in the Western Province of PNG, serves as a timely reminder of the risks of doing business in developing nations and the need to manage such risks through appropriate mitigation measures. This paper discusses some of the issues associated with expropriation risk in developing nations such as PNG.
The Ok Tedi copper/ gold mine was formerly operated by BHP Billiton and has to date been extremely profitable for PNG in GDP terms. Despite this, the mine has been highly controversial as a result of the extensive environmental damage caused primarily by the collapse of the mine’s tailings dam system in the early 1980’s.
Concerned about the ongoing environmental damage and mindful of the competing desire of the PNG Government (a minority participant in the project) to continue mine operations, an exit plan was developed by BHP Billiton (in consultation with the PNG Government and other key stakeholders) under which majority ownership of Ok Tedi was to be transferred to a special trust entity (limited by guarantee) known as the “PNG Sustainable Development Program Limited” (PNGSDP), to be held and managed for the benefit of the people of Western Province. Under PNGSDP’s articles of association, revenue earned from PNGSDP’s majority interest in the mine was to be paid into an offshore trust fund established in Singapore and those funds were to be used, amongst other things, for the benefit of the people of Western Province and the broader PNG community under the approval of the PNGSDP Board (comprised of directors appointed by BHP Billiton, the PNG Government and other nominees).
Majority ownership of Ok Tedi was eventually transferred to PNGSDP in 2002 and as part of such transfer, the PNG Government agreed amongst other things (under an agreement between BHP Billiton and the PNG Government as ratified by Parliament) to effectively release BHP Billiton from liabilities associated with environmental damage at Ok Tedi.
Following a bitter and widely publicised deterioration in relations between the PNG Government and PNGSDP (through its then chairman and BHP Billiton board nominee, Dr Ross Garnaut, and his successor and former PNG Prime Minister, Sir Mekere Morauta), the PNG Government in September of this year voted by an overwhelming parliamentary majority to pass legislation to effectively acquire 100% ownership of Ok Tedi. As at the date of this paper, the PNG Government has yet to announce how and to what extent PNGSDP will be compensated for the compulsory acquisition of its majority interest. In particular, as part of its takeover of Ok Tedi the PNG Government has reportedly assumed control of the Singaporean trust fund operated by PNGSDP (reported to hold in the order of $AUD1.5 billion). It is unclear whether the relevant compensation package to PNGSDP will include compensation for that aspect of the expropriation (assuming such action was valid at law).
The sovereign right of nation States to exercise expropriation power
It is an undisputed and well established principle of international law that States have the sovereign right to compulsorily acquire property within their jurisdiction for the national or public interest or for the purpose of maintaining peace, order and good government. Often, the issue of expropriation, or what is sometimes termed “nationalisation”, arises in the context of sovereign risk and its application in developing nations where the rule of law, the observance of due process and the effectiveness of law enforcement agencies to uphold and protect proprietary rights is uncertain.
The exercise of expropriation power is by no means limited to the governments of developing nations. The decision by the Argentinean Government in 2012 to expropriate the interests of Repsol in the offshore oil sector industry in Argentina demonstrates the vulnerability of investors to expropriation risk even in the developed world.
However, a project investor in a developing nation can adopt measures to help mitigate the risks associated with expropriation, particularly for major resource projects which are the subject of a development agreement between the investor and the host State. Some of these measures are described below.
Potential mitigation measures
As part of any due diligence investigation into the potential acquisition or development of a major resource project, prospective investors should carefully consider the legal basis on which a host State may exercise its expropriation power and the rights of affected property owners in the event of expropriation.
Usually the right of the host State to expropriate property will be expressly set out in its Constitution or other domestic legislation. In the case of PNG, the Constitution expressly prohibits the “unjust deprivation of property” and confers upon affected property owners the right to “just compensation” for property taken. The right to just compensation is a universal feature of any expropriation regime. However, prospective investors should not be content to accept a mere right to compensation. Consideration should also be given to the mechanisms (if any) contained in the domestic laws of the host State by which the quantum of compensation will be determined, and whether such mechanisms are adequate for the investor’s purposes and more relevantly those of the project financier. On this particular aspect, the PNG Constitution remains largely silent and instead leaves the matter of compensation to be determined somewhat loosely “on just terms” by the relevant expropriating authority.
Accordingly, the absence of adequate mechanisms to determine “just compensation” should raise concerns for any prospective investor. The risk can however be mitigated by having appropriate protections incorporated into a development agreement between the investor and the host State which deal clearly and satisfactorily with the issue of expropriation and the methodologies for determining just compensation. Such mechanisms can be designed to protect the investor in the following way:
- if the development agreement is ratified by an act of Parliament so as to have the effect of law (as would normally be the case for major resource projects such as Ok Tedi), the investor’s rights under the development agreement (including its right to receive just compensation) would be protected both under contract and by law. This said, if the host State undertakes an expropriation via a new law then such action will likely only constitute a breach of contract and not law. The actions with respect to Ok Tedi would appear to be consistent with this analysis;
- subject to the terms of the relevant ratifying legislation, the terms of the development agreement could prevail in the event of any conflict or inconsistency with the domestic laws of the host State;
- the rights of the investor in relation to expropriation and just compensation would be enforceable in accordance with the independent dispute resolution procedures agreed and set out in the development agreement with the host State (e.g. arbitration or expert determination in a jurisdiction using a procedure or law which are not those of the host State); and
- most importantly, the development agreement would provide the parties with a clear and mutually accepted basis on which the host State may exercise its expropriation power (i.e. in accordance with due process and on a non-discriminatory basis). It would also clearly set out the rights and obligations of the parties during the expropriation process and the manner in which just compensation would be determined so as to reflect fair market value.
Development agreements will also often have what is known as a “stabilisation clause” to protect the investor against changes in the laws of the host State which adversely impact its rights under the development agreement or its interest in the relevant project. Such mechanisms may require the parties to negotiate and agree an outcome which will effectively restore the affected rights of the investor to a level equivalent to what they would have been if the change in law had not occurred. This would also apply in respect of laws passed by the host State to expropriate the assets of the investor and would oblige the host State to take the steps necessary to “unwind” or make good any resultant adverse impacts on the investor. Where expropriation is effected by a change in the domestic law of the host State then the stabilisation clause would only be relevant to the issue of damages if what was expropriated was something less than the project as a whole.
Another form of protection which an investor may have is where there are existing international or bilateral treaty arrangements between the host State and the government of the domicile of the investor (as is typically the case between member nations of the Commonwealth for example), which oblige the host State to behave in a particular way. PNG for example has adopted the Judgment Enforcement (Reciprocal Arrangements) Act 1976 (PNG) under which it is committed to the reciprocal enforcement of foreign judgement debts entered by the courts of certain recognised States, including those of Australia, Malaysia, New Zealand, Singapore, the United Kingdom and the United States of America. Such legislation could be used to enforce a foreign judgement debt issued by the courts of an applicable jurisdiction to enable an investor to recover “just compensation” for property taken.
Alternatively, such treaties or bilateral agreements may prohibit expropriation or expropriation without equitable and just compensation by a host State, such that if expropriation occurs pursuant to a change in domestic law then that law will be illegal and unenforceable without a corresponding change in the relevant treaty or bilateral agreement. The reason for this is that such a treaty is an international law which takes precedence over the domestic law of the host State.
The implications of the compulsory acquisition of Ok Tedi by the PNG Government continue to unfold and it remains to be seen whether the parties will be able to achieve an amicable resolution of the dispute between them. Whilst the actions of the PNG Government have naturally prompted concerns around issues of sovereign risk and the “business friendliness” of developing nations generally, clearly from the point of view of investors there are measures (as described above) that can be adopted to manage and, where appropriate, limit the relevant levels of exposure. These measures can be tailored to suit the particular needs of individual investors and should be carefully considered as a matter of priority before any major investment decision is made or a development agreement is entered into with the relevant host State.
In the specific case of Ok Tedi, a particular concern for BHP Billiton is the legislative effect of the removal by the PNG Government of the release from liability (granted to BHP Billiton in relation to environmental damage at Ok Tedi), which was the cornerstone of the transaction entered into by BHP Billiton when it agreed to handover the mine’s operations to PNGSDP. The legal ramifications of such action will no doubt place PNG under further scrutiny from a foreign investment perspective.