The Sapphire Petroleum Case

The Sapphire International Petroleum Ltd. v. National Iran Oil Company (NIOC) award was rendered more than 45 years ago, and to this day remains one of the most relied upon – and one of the most discussed – cases on standards of compensation.

In 1958, Sapphire and NIOC entered into a contract to expand the production and exportation of Iranian oil and set up a joint venture, the Iranian Canada Oil Company (IRCAN), to carry out the terms of the contract on their behalf. The contract was to be performed in two phases: First, Sapphire would be exclusively in charge of the prospection through IRCAN, second, IRCAN would act on behalf of both parties during the production phase.

Sapphire was contractually entitled to receive from NIOC complete reimbursement of its expenses incurred during the prospection phase. Conversely, NIOC had the right to cancel the contract if Sapphire failed to complete its prospection obligations at the end of the initial phase. Sapphire would in that case be liable to pay NIOC a guaranteed indemnity of US$350,000.

Sapphire quickly started prospecting in the concession area and within a few months claimed reimbursement of it expenses, in accordance with the contract. NIOC, however, refused to refund the expenses submitted by Sapphire, arguing that it was not consulted before the prospection operations began as required by the contract. After unsuccessfully seeking assistance from the Shah of Iran and in light of NIOC’s position, Sapphire ceased prospection operations. In early 1961, NIOC terminated the contract and cashed the US$350,000 guarantee on the grounds that Sapphire had failed to carry out its drilling obligations.

In September 1960, three months before NIOC’s termination of the contract, Sapphire notified NIOC of its request for arbitration and appointed an arbitrator. As a result of NIOC’s refusal to appoint an arbitrator, Sapphire moved to have a sole arbitrator nominated by the President of the Swiss Federal Court, as provided in the contract. The sole arbitrator, applying general principles of law, found that Sapphire had fulfilled its initial obligations under the contract and that NIOC’s deliberate failure to carry out its obligations breached the contract and justified Sapphire’s non-performance of its remaining contractual obligations.

The arbitrator also applied general principles of law to the determination of damages, but also used the principle of ex aequo et bono (i.e., equity) to the issue of lost profits. Sapphire had claimed expenses incurred before and after the termination of the contract. The arbitrator refused to award compensation for the expenses incurred before the termination of the contract, but awarded compensation for the expenses incurred afterwards. Sapphire had also claimed a refund of the US$350,000 guaranteed indemnity, which the arbitrator granted. Finally, Sapphire claimed loss of profits it expected to earn when performing the contract. It is on the latter point that the Sapphire award reaches its seminal character.

The sole arbitrator followed a two-fold reasoning when addressing the claim for loss of profits. The first step was to determine whether a loss of opportunity can give a legal right to compensation. The arbitrator held:

“It is not necessary to prove the exact damage in order to award damages. On the contrary, when such proof is impossible, particularly as a result of the behaviour of the author of the damage, it is enough for the judge to be able to admit with sufficient probability the existence and extent of the damage.”5

The arbitrator considered that Sapphire had demonstrated a sufficient probability of the success of the venture if it had been able to complete the prospection phase and that Sapphire could therefore claim loss of profits. The arbitrator then went on to decide on an amount to be awarded to Sapphire for this head of claim. He resorted to the principle of ex aequo et bono to determine the amount of the compensation for the loss of opportunity on the basis of available evidence. The arbitrator considered that a compensation in the amount of US$2 million was reasonable and equitable.6

The Sapphire Petroleum findings continue to be cited and followed in major contemporary cases. The Award in LETCO v. Liberia and LIAMCO v. Libya, for instance, rely on the Sapphire rationale when discussing the issue of compensation for lost profits.7

The AMCO v. Indonesia Tribunal also based its decision to award compensation for lost profits on the Sapphire award, which it directly quotes:

“According to the generally held view the object is to place the party to whom they are awarded in the same pecuniary position they would have been in if the contract had been performed in the manner provided for by the parties at the time of its conclusion.”8

More recently, the Tribunal in Waste Management v. Mexico went through a careful and detailed analysis of the findings on the issue of lost profits in the Sapphire award. However, it ultimately concluded that the Sapphire findings were not directly relevant to the present case as they dealt with contractual breaches where the Waste Management case was about expropriations.9

In sum, the Sapphire Petroleum standard remains the foundation for determining the compensation of lost profits in international arbitration. It reflects the evolution of the principles of international law on this element of damages and parties and tribunals continue to rely on its rationale today.