Legal Framework: Summary & Overview

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Legal Framework:Summary & Overview

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Functions of the legal framework• Defines the terms of the investment project, and commits

parties to certain rights and obligations

• Allocates risks, costs, benefits (including revenues) and responsibilities

• Sets standards for social, health, safety and environmental

impacts and performance

• Shapes the extent to which the investment provides opportunities for linkages and employment

• Allocates responsibilities for regulating, auditing, monitoring,

and enforcing the respective rights and obligations

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Scope of the legal framework• Covers the full timeline of an investment, for e.g.:

– Incentives to attract investment– Exploration – Production– Transportation (pipelines, rail, etc)– Decommissioning and closure

• Governs the activities, rights and obligations of numerous actors, for e.g.:– Investors– Lenders and insurers– Contractors– Suppliers– Host government agencies– Land owners and affected communities

• Covers (or should cover) a non-exhaustive list of issues, for e.g.:– Allocation of rights– Land title– Resettlement and compensation– Taxes, royalties, equity, profit share– Accounting practices– Applicable standards– Minority shareholder rights– Dispute mechanisms, grievance mechanisms– Stabilization– Transparency and disclosure

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Hierarchy of laws (?)

Constitution

Laws

Regulations

Contracts

International law

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Legal Instruments: A Briefing

• Constitution

– Ownership of the resources

– Basic structures of government (incl. roles of different actors, degree of centralization)

– Rights of citizens

– Durable & reigns supreme

• Legislation/statutes

– Passed by Parliament

– Can cover land rights, mining or petroleum codes, taxation, revenue management, environmental protection, etc…

• Regulations

– Establish systems and procedures that operationalize statutory requirements

– Typically established by executive bodies (e.g., Ministries, Regulatory Agencies)

– Statute sets out the bounds of what can be included in Regulations

Nati

onal

Law

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National Law– coverage ranges along a spectrum

Very weak national law; All terms negotiated between the country and the investor.Most common in developing countries.

Many terms in the law (e.g. environmental standards, tendering processes, etc) but the law permits and requires negotiation on project-specific terms (fiscal regime, social obligations, etc…)Contract terms may supersede the law.Limited ability to change terms over time.

Model Contract in the law; limited terms for negotiation with the investor (fiscal terms, work program, local content)

All rules for investment project set in law; only a license granted in each situation. - Most common in developed countries.Rules can be unilaterally changed overtime (by parliament or regulations).

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Legal Instruments: A Briefing, cont’d

• Contracts

– Distinct agreement between two or more parties, exercising free will, to bind one another

– Binding on named parties only, though thirds party rights are implicated

– Allows more specificity to a particular project

– At least four basic types of contracts: Concession or license agreement, JV, Production-sharing agreement, Service agreement

• Implications of including the terms of the deal in contracts

– Ability to change the terms is limited (requires agreement between the parties)• Creates the “baseline” for future renegotiations• International law makes renegotiations more difficult

– Little (or usually no) room for involvement of non-parties in the negotiation

– Asymmetry of resources, knowledge, experience between the parties

– Often confidential

– Creates a web of different terms, arrangements, etc.– very difficult to monitor and enforce

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Web of contracts

From Investment Contracts and Sustainable Development, IIED

More than 100 contracts may govern one particular investment:

-Concession contracts between the government and the investor (or consortium) regulating exploration and development-Agreements between the investor and the government(s) regulating the construction and operation of transport (pipelines, rail, ports) – and in some cases, intergovernmental agreements-Shareholder agreements among consortium members-Lending agreements, regulating the financing of the project-Sales and off-take agreements-Community development agreements

Consider: are all stakeholders’ rights adequately covered by contracts? If not, where and how in the legal framework should they be addressed?

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Joint Operating

Agreement

(JOA)

Network of Contracts – An Example from Oil, but Mining is Similar

IOC Contractor Parties (to PSA and JOA)

EXPLORATION

And/or

EXPLOITATION

CONTRACT

Operating Company

Non profit making operating company

Controls and governs

Pipeline Company

Profit making developer and operator of the export

pipeline

State oil company/entity

Pipeline Company owners (shareholders)

Throughput contracts

Throughput contracts

Lifters of crude oil/oil companies/oil traders

Oil sales agreements

Oil sales agreements

Sub contractors/sub-sub contractors/services

Controls and governs

Party: on behalf of the state and as a

participant

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The Relationship between Laws and Contracts

• In many cases, the “rules” will be found in a combination of the laws, regulations and contracts (see Sierra Leone example), but the balance between the two varies:

• In some cases, contracts will try to opt out of statutes, supersede applicable legislation, or exempt a project from legislative changes

– Have to read each contract to know the extent to which the legal regime applies– Has implications for ability to monitor and enforce– Has implications for the standards applicable to a particular project (may differ by project)

Very weak national law; All terms negotiated between the country and the investor.

Many terms in the law (e.g. environmental standards, tendering processes, etc); with room for negotiation on project-specific terms (fiscal regime, social obligations, etc…)

Model Contract in the law; limited terms for negotiation with the investor (fiscal terms, work program, local content)

All rules for investment project set in law; only a license granted in each situation.

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Example of Sierra Leone - Rutile

Provision Where Located

Work Programme/Feasibility Studies

Mines & Minerals Decree, Mines & Minerals Regulations, Contract

Prospecting/Exploration/Mining Licenses

Decree, Regulations, Contract

Rights to Additional Minerals Decree, Regulations, Contract

Use of Water on or Adjacent to Concession Area

Decree, Regulations (dredging), Contract

Construction of Infrastructure Decree, Regulations, Contract

Training of Local Workers Decree, Regulations, Contract

Reporting Requirements Decree, Regulations, Contract

Surrender of Lands at End of License

Decree, Contract

Examples – applicable lawMining Law Superseding the Contract:

This Agreement shall be governed by, interpreted, and construed in accordance with the Laws of (Country), as such Laws are set forth in duly adopted and published legislation, and supplemented by the standards, customs, and usage generally applied in the international mining industry for those matters not covered by (Country) Laws and as may be applicable. If there are conflicts between this Agreement and the Mining Proclamation or Mining Tax Proclamation, including definitions, then the Mining Proclamation and the Mining Tax Proclamation shall govern.

Contract Superseding the Law:

The (Government) declares that this Agreement is authorized by (Country) law. It is expressly understood that, for the entire period of its validity, the present Agreement shall constitute the law applicable between the Parties. Consequently, domestic law of the (Government), as in force and effect on the date of signature of this Agreement, shall be applicable in the interpretation of this Agreement, as a complementary tool, only to the extent that this Agreement does not exhaustively govern the issue.

• From MMDA

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Law versus Contract

More in Contract,

Less in Law

More in Law, Less in

Contract

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What are the costs and benefits of putting more in law than in contract and vice versa?

If more terms in legislation: • Increased flexibility of government to amend the rules• Helps to address asymmetry of bargaining power (less room for negotiation) • Limited discretion (and risk of corruption) of negotiators• Time and cash-flow pressures of contract negotiations may make it more

difficult to strengthen the protection of local or public interests, including through public consultation/input

• Fragmented legal system with disparate and potentially conflicting contracts and laws is more challenging to monitor and enforce

• Greater transparency of terms

If more terms in contract: • Allows room for tailoring to particular circumstances.

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Better in Law or Contract?More in

Contract, Less in Law

More in Law, Less in

Contract

- Fiscal terms- CSR commitments- Environmental and social obligations- Labor obligations- Work program obligations- Resettlement- Infrastructure arrangements- Local content- Revenue management arrangements- Community engagement and development obligations (including the definition of the "local community")

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International law

• Investment treaties provide further protection to foreign investment

• May also strengthen the legal value of investment contracts • Creates additional legal remedies in international tribunals• Treaty protection depends on investor’s corporate structure

(see Mittal Steel example)• Other international legal norms and standards form part of

the legal framework, e.g. IFC performance standards, OECD Guidelines, etc… (contracts and laws may refer to them)

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Complicated Corporate Structures

From Heavy Mittal, 2006

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Governance checklist

Clear Policies Are Government policy goals for the sector clear?

EnablingLaws

Are the necessary laws in place to enable policyobjectives to be achieved?

Enacting Regulations

Has the law been enacted into effective regulations?

License Agreements

Are individual license agreements enforceable and consistent with policy, law and regulations?

Competent RegulatoryAgencies

Are the systems and institutions in placeto monitor and ensure compliance and to achievepolicy objectives?

Source: Revenue Watch Institute

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Aspects of governance and necessary institutions

Setting the investment

environment

Government policies and

strategies for resource-based development

Drafting laws and regulations (in

different sectors)

Preparing for a project

Requiring and assessing project feasibility studies, fiscal models, EIAs

and SIAs

Preparing tender documents and

process (if doing a competitive bid)

Drafting model contracts

Community consultations and

engagement

Negotiating with an investor

Multi-disciplinary team and

negotiation strategy

Contractual provisions

Implementing the contract

Monitoring to ensure contract

compliance

Enforcement of legal and

contractual obligations

Managing potential disputes

and grievances

Managing and Allocating the

revenues

Administering a fund, earmarks, or

budgetary allocations

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Adapting to Changing Circumstances • Why are reforms/renegotiations likely in extractive industries?

– Agreements of such long duration will undergo fundamental changes in circumstance at least once in their lifetime

– Many contracts and laws were drafted/passed in times of privatization – countries prioritizing attracting investment (with encouragement of international institutions)

– Some contracts entered into with corrupt, transition, or incompetent governments.– Volatility of the sector and major price changes over time have changed underlying

economics:• OIL: $25/barrel in 2000 to over $130 ($100 today)• GOLD: $282/ounce in 2000 to over $1,800 ($1,400 today)

– Economic importance of these contracts to host countries (number of resource-dependent countries has risen over the last 15 years, says OPM), so the “deals” are sensitive targets of government and public concern

– Asymmetry of negotiating capacity, knowledge, reference tools, etc…, means original deal may be imbalanced

– Environmental, labor, health, safety and human rights standards are still evolving in many countries that are developing their legal regimes

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Adapting to Changing Circumstances • Investors’ response: stabilization

– Sought by investors in developing countries to prevent the government from changing the conditions or the investment environment within which a contract was negotiated.

– Range along a spectrum of limitations on government actions– In extreme cases (like Mittal in Liberia), any changes to the law made in the future will not apply to

the concessionaire without their consent; includes changes to the constitution, to important policy areas (environment, health), to int’l law obligations (human rights), or to other domestic policy areas (tax, local content)

– Many lenders insist on this “stability” as a fundamental aspect of the bankability of an investment. • Does “freezing” terms in a contract achieve stability?

– To an extent, yes:• May make governments think twice about such changes (“chilling effect” on new legislation)• May be able to sue governments that breach a stabilization agreement and at least get compensated• Give investors leverage to negotiate a lesser degree of or a delay in implementation

– But to an extent, no:• Consider that many renegotiations take place even when there are stabilization clauses.• “Stabilizing” a bad deal may not be stable at all!

• Queries:– Are there other ways to achieve the predictability that investors seek other than through

stabilization clauses? – Is it only host governments that need flexibility? What happens if a company wants to change the

terms of its contract?

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How should the legal/fiscal framework reconcile the competing needs for flexibility and predictability?

• A fair deal to begin with should be more robust– Requires addressing the asymmetry of resources, information, capacity,

etc• Legislation rather than contracts?

– In developed countries, governments adjust their tax systems regularly and investors comply. Companies invest with a perception that the fiscal and regulatory regime will be adjusted “reasonably.”

– Including terms in legislation rather than confidential contracts can also minimize distrust and therefore calls from the public for renegotiation.

• Build in internal mechanisms in the contract to rebalance interests in changed circumstances– Progressive fiscal regimes– Limiting stabilization clauses; exclude compliance with international

standards or “non-discriminatory” legislation concerning the protection of health, safety, labor and the environment.

• Review periods

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What are the issues to consider in designing an allocation system?

• Decrease corruption• Get maximum value for the resources• Ensure effective exploration of resources• Aligning the resource development with

national development strategy

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Allocation of rights

• Direct negotiations– Interested parties directly apply to the Minister (or

responsible entity)• First come first served

– First applicant to apply is awarded the right• Competitive bidding (auctions)

– Bids are invited from applicants, and the Ministry chooses the most favorable

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Competitive Bidding• Competitive bidding/auctions have typically been used in the oil industry for

decades; less common in mining• A key factor is having competition; Investors are more likely to bid, and to

compete, where geology is known; where geology is not known, risks of under- (or over-) bidding is much more likely.

– Geology of oil means lends itself to more accurate estimations of scale and value earlier on in the exploration cycle; economics may be uncertain but there can be a fairly high level of certainty that oil is present.

– Mineral deposits though are not contiguous and less clustered (iron ore and coal may be easier than others).

• Is on the rise in developing countries that are evaluating their legal systems (our survey of 29 mineral rich countries showed more than half introduced mandatory competitive bidding for minerals in the last decade, 3 more to ratify soon.)

• In some countries seems to be linked to increased awareness that transfers of mineral assets were done for far below their actual value (e.g. India, DRC).

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What factors can be biddable?• Signature bonuses

– Attractive to governments because it provides upfront payment, but risk of either over or under valuing the resources

• Work programs– Commitment to a certain amount of exploration in a certain time period

(need capacity to evaluate)• Fiscal variables

– Royalties, bonuses, profit/production shares, resource rent tax, state equity

• Other criteria– Investors bid for infrastructure investment (including “extra”

infrastructure), upstream linkages, downstream linkages, local content programs, technology transfer, local community development

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Solutions for allocation criteria and concerns• Decrease corruption

– Increase transparency• Bids may help with transparency if the bid, evaluation criteria, procedure, offers and awards are public• But other types of allocation systems can also be similarly transparent

– Minimize discretion in awarding the rights• Clear criteria in a bid may minimize discretion (although some discretion may be helpful if number of

applicants is very low or for feasibility of work program bidding, for example)• But other systems can also be designed with clear award criteria• In all cases, external monitors and independent auditors can be helpful• Note that a first come first served system can eliminate all subjective selection (e.g. Chile)

• Get maximum value for the resources– In developing countries, investors often have better idea of the value of the resources than the Gov; a bid may

indicate value, assuming adequate competition (can also set minimum bid); geo-info also helps.– Beware “winner’s curse”: chronic overbidding in oil industry has led to renegotiations down the road– Alternatively, can invest in geological survey data to increase the Gov’s knowledge of its resource base

• Ensure effective exploration of resources– Require a fee to participate in bid; include bonus payments, advance fees or surface rental payments to deter

speculation and license idling (can require bonus payments in any system)– Set prequalification criteria (whether for a bid or otherwise); require documentation of previous technical

experience and financial strength (does not prevent “exceptions,” as in India and Liberia)– Include “use it or lose it” provisions in legislation or mining agreements

• Aligning the resource development with national development strategy– A competitive bidding system may compel policy-makers to plan and prioritize resource-based development,

since tenders will have to articulate evaluation criteria (e.g. Aynak deposit in Afghanistan)– BUT, such planning should be done before rights are awarded in any allocation scheme

Is competitive bidding the

best solution for these

design issues?

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Challenges of competitive bidding systems

• Little quantitative evidence showing the benefits of competitive bidding• “The Winner’s Curse”– overbidding leading to renegotiations down the road.

Studies have shown chronic overbidding. • Administratively very difficult for governments, and requires substantial capacity to

carry out a tender (Afghanistan’s recent tender involved substantial WB support).• Timing of bid – can it be done in early exploration (lack of interest, but also the

time when government doesn’t know how to value the resources) – Usually the incentive to carry out prospecting/early exploration is the

knowledge that the company will have the licence to develop. Can they be separated?

• The lower the geo-info, the higher a return investors will demand for taking on exploration ‘risk’. How can government improve its level of geological knowledge? – Invest in geosurveys (funded by budget, dedicated portion of royalties, donors,

etc…)– Service agreement with a company to do geological surveys, in the knowledge

that the country will retain the rights and the knowledge? Is there an incentive for the company? Allow them to sell data packages for bid rounds?