Spearhead Analysis – 20.06.2018
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
Pakistan has suffered serious financial set-backs borne out of incompetence and an inability to understand the ramifications of International arbitration. The two cases of Karkey and Reko Diq have potentially exposed Pakistan to significant financial losses and inflicted immense reputational damage on the country. This is all the more worrisome at a time when the country needs to build a positive image to attract investment and bolster its dwindling foreign exchange reserves. An abject lack of understanding of international laws and dispute resolution; and an inability to manage international negotiations appears to have created serious fault lines within the system that pose great threats to future partnerships. It is important to understand the two cases to realise the seriousness of the issue facing Pakistan. In the recent past Pakistan has faced similar situations on an international level, such as the recent Habib Bank Limited New York case, where a fine of US$225 Million had to be paid out and the operations closed. Similarly, in the Reko Diq and Karkey cases the government faces potential losses of around US$12.5 Billion.
Back in April 2011, a Turkish company, Karkey Karadeniz Elektrik Uretim (KKEU) leased a sea-vessel based power generation plant to Pakistan with a rated capacity of 231 Megawatts (MW) under a five-year contract valued at US$565 Million. This was one of the 12 Rental Power Projects (RPPs), allowed to be set up during the tenure of the PPP-led government, to overcome the energy shortfall in the country. The Karkey plant failed to generate the projected electricity as required under the agreement, although US$9 Million was paid in advance as capacity charges to the firm. The plant managed to produce only 30-55MW at a cost of Rs.41 per unit, which was a breach of the contract terms. This led to a 50 per cent increase in the refund claim by the government of Pakistan, from US$80 Million to US$120 Million.
A petition was filed by PML-N stalwart Khawaja Asif and Faisal Saleh Hayat, which called for shutting down all RPPs in the country, and the contract was struck down by the Supreme Court of Pakistan by the then Chief Justice Iftikhar Chaudhry in 2012, based on charges of breach of contract by the Turkish firm. The Supreme Court also took Suo Moto notice against all RPPs from 2006 onwards, and in its March 30, 2012 judgement, declared all RPP deals as null and void and instructed the National Accountability Board (NAB) to take action against the RPPs.
In 2012, NAB attempted to settle the issue with Karkey with the Turkish firm agreeing to reimburse US$17.5 Million to Pakistan, but the then Chief Justice Iftikhar Chaudhry remained adamant on recovering the full US$120 Million claim from Karkey. This prompted Karkey to approach the international arbitration forum, based on the Bilateral Investment Treaty (BIT) executed between Turkey and Pakistan. Karkey approached the International Centre for Settlement of Investment Disputes (ICSID), an arm of the World Bank which offers arbitration and conciliation services for governments and private foreign investors’ disputes and served a notice on the government of Pakistan for breaching of the BIT terms on May 19, 2012, with an expected claim of US$700 Million. After the expiry of the six month cooling period under the notice on November 2012, Karkey served a second notice to the government of Pakistan on November 23, 2012, warning that it would now submit the dispute in the ICSID for arbitration proceedings. Karkey then filed a request for arbitration with ICSID in Washington on January 2013, which was registered on February 8, 2013. The case was filed for losses due to its vessels not being allowed to leave Karachi Port for almost 16 months. It included the loss of revenue on the vessels after April 1, 2012, direct and indirect costs and losses incurred by Karkey and damage or depreciation to the vessels.
It is a fact that Pakistan’s success rate in international arbitration cases at two per cent is abysmally low compared to its Asian competitor India, which has a success rate of 60 per cent. It is also relevant to note that the national courts have no jurisdiction to challenge ICSID awards and Karkey was in a strong position to win the case. Despite such high stakes the inaction of the government of Pakistan in trying to resolve the issue remains inexplicable. Karkey also filed the case against Pakistan in the London Court of International Arbitration.
The ICSID in its verdict in August 2017 in favour of Karkey imposed a fine of US$600 Million on Pakistan. According to the ICSID award, Pakistan was to pay a Rs.80 Billion fine and was also required to pay US$5.6 Million per month as interest to Karkey. The parties concerned had four months to move for annulment of the award. Pakistan managed to get a stay on the execution of the award, but the international arbitrators raised several pertinent questions over the Supreme Court’s judgment in the RPP case:
- In their opinion, the fault lay in the SC decision to declare all RPPs contract void as they should have examined each RPP contract individually before voiding all of them for corruption.
- The ICSID also rejected Pakistan’s argument that the country was bound to comply with local legal judgments. The tribunal held that the actions of the local judiciary can be considered actions of that state.
Pakistan continued to try for an out of court settlement, and managed to get a stay from the ICSID over the execution of the multi-million-dollar award to Karkey, while offering to give compensation of Rs.700 Million to Karkey through the Turkish government. By October 2017 the award had gone to US$800 Million due to accrual of interest.
In June 2018 Pakistan now faces the specter of default to the tune of US$1 Billion on account of damages and per day penalty slapped by the ICSID for breach of contract with Karkey. If the amount is not paid it will result in a default and Karkey will be in position to file a law suit in any jurisdiction for seizing assets of Pakistan in that particular country. Pakistan has basically lost the case in ICSID. Given the rapidly falling foreign exchange reserves this judgement has come at a critical time for Pakistan. The government had since 2013 to try and resolve the issue but failed and now Pakistan is out of pocket for billions of dollars in terms of legal fees and compensation claims. The Karkey case highlights the competence and knowledge gaps within the system for dealing with international laws that sometimes create highly unwarranted situations resulting in heavy losses for the country.
Reko Diq, a part of the Tethyan Magmatic Arc, which is a mineral belt that originates from Eastern Europe and runs through Iran, Afghanistan and turns upward towards Pakistan, has become another serious issue for Pakistan.
In 1990, the Australian based Broken Hill Proprietary (BHP) showed an interest in the gold and copper mines in Balochistan. BHP entered into the Chagai Hills Exploration Joint Venture Agreement (Chejva) with the government of Balochistan in 1993. In 1998, BHP suspended its exploratory work and handed over its obligations to another Australian company, Mincor Resources, that took over the work in 2000. The Balochistan government and BHP through an addendum to the original joint venture agreement, agreed to the change and radically reduced BHP’s financing obligations under the JV. Under this arrangement, the Balochistan government was entitled to earn 25 per cent, if it invested 25 per cent in the project.
Mincor Resources incorporated Tethyan Copper Company in Australia (TCCA) as a special purpose vehicle (SPV) for the project. Then TCCA incorporated the Tethyan Copper Company Pakistan (TCCP) as a 100 per cent owned subsidiary in 2000. Mincor also registered the TCCA on the Australian Stock Exchange.
In 2006 Mincor sought to sell its share on the stock exchange to other mining companies and TCCA was acquired by Antofagasta and Barrick Gold for an amount of US$240 Million. The then provincial government of Balochistan approved the TCCA acquisition by Antofagasta and Barrick Gold. In 2007, TCCA started a process with provincial and federal governments for a customised mineral agreement for undertaking mine development. According to a TCCA 2010 feasibility study, 256,000 ounces of gold and 420 million pounds of copper were to be produced over a 56-year period. The ore was to be crushed, converted into slurry, and transported through a pipeline from Reko Diq to Gwadar and from there to foreign smelters and refineries owned by the TCCA. The estimated capital outlay of the project was US$3.3 Billion and the provincial government was to get 25 per cent of the profit against its 25 per cent investment.
The Balochistan government rejected the mining lease application on November 15, 2011, and refused to grant a mining licence to TCCA for the Reko Diq gold-cum-copper project. The provincial government, had already decided to install its own refinery for the processing of gold and copper and allocated substantial funds for this purpose. The naïve Chief Secretary at that time stated that TCCA could go to court against the decision. TCCA went back to the government for clarification, but the government adopted the stance that TCC took ‘too long’ to complete its feasibility study and that it was “cheating” Balochistan by under-valuing the worth of the copper and gold.
In 2013, the Supreme Court declared Chejva and all of its successor agreements null and void and that the TCC had no legal rights to explore and mine in Reko Diq. In its ruling, a three-judge bench of the apex court, headed by then Chief Justice Iftikhar Chaudhry, stated that the Chagai Hills Exploration Joint Venture Agreement — signed between the Balochistan government and Australian mining company BHP in 1993 — was in conflict with the laws of the country. The bench added that all amendments made to the agreement after its signing were unlawful and in contradiction with the agreement. It further stated that TCC no longer had any rights in relation to the Reko Diq agreement.
An arbitration claim had also been submitted in 2012 by the Tethyan Copper Company Pty Ltd (TCC), with the ICSID over the unlawful denial of mining rights for the Reko Diq project. The international tribunal rejected Pakistan’s final defence against liability and confirmed that Pakistan had violated several provisions of its BIT with Australia, where TCC was incorporated. A final ruling on the quantum of damages to be paid is expected in 2018, with Tethyan expected to receive an award entitling it to the fair market value of the project at the time that the mining lease application was denied. Pakistan potentially faces US$11.43 Billion in damage claims in the Reko Diq mining case in international courts due to corrupt practices and inefficiencies of successive governments of Balochistan.
Serious questions have been raised within Pakistan over the manner in which the provincial governments allowed change of ownership from one Australian company to two others from 1998 to 2006 despite the fact that there was no such clause in the original Chagai Hills Joint Venture Exploration Agreement. Successive Balochistan governments appear to have mishandled the case, as a result of corrupt practices, inefficiencies and incompetence. Pakistan is defending the US$11.43 Billion claim through its International Arbitration Unit, but for now it is a sword hanging over the head of the government. Trying to limit the damage, the final award is expected to be significantly below the US$11.5 Billion claim with a decision expected by early 2019.
Pakistan is said to have paid an amount of GBP20 Million as legal fees for these two cases that it has all but lost. The law firm Allen and Overy of London, which was hired to defend the two cases, has been reimbursed for an amount of Rs.4 Billion, but the country has had to face defeat in both the cases at ICSID. Pakistan did not get single watt of electricity in case of Karkey and no benefit accrued to Balochistan in case of Reko Diq, yet Pakistan will have to pay multi-billion dollars in damages to these companies. It is a matter that requires a thorough investigation and the blame needs to be apportioned on those that have caused such a huge loss to Pakistan. With falling reserves, the country is in no position to absorb a loss of this magnitude on account of damages compensation. The issue has also exposed the lack of understanding of international arbitration and how it can create highly unwarranted situations such as Karkey and Reko Diq.