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Rishi Kumar Dugar
Roman statesman Marcus Tullius Cicero said, “According to the law of nature it is only fair that no one should become richer through damages and injuries suffered by another”. Alas, it is not easy to quantify damages in the law of commercial arbitrations.
In a typical arbitration claim, Claimants not only claim costs incurred up to date of breach or expropriation but also compensation for future profits in a but-for scenario. A recurring challenge raised by Respondents, in particular where a project or business has little or no track record of profits, is those future projections are too speculative so Claimants’ compensation should be limited to costs incurred.
This article summarises, reasonings provided by Arbitral Tribunals in a few recent arbitral awards where this issue was raised.
Tribunals use several criteria to assess future projections, including:
It is surprising, that these different criteria are not weighted equally and Arbitral Tribunals focus more on future profitability than past performance.
Generation of future cash flows
Arbitral Tribunals refuse to compensate investors for future profits when there was insufficient evidence, that projects could generate positive cash flows. In Bear Creek Mining Corporation v. Republic of Peru (ICSID ARB/14/21), Bear Creek, a Canadian mining company, claimed US$224.2 million in damages following revocation in 2011 of its mining concessions for the Santa Ana silver mining project in Peru.
The concessions were granted in 2007 and 2008. Claimant started exploration activities and had applied for a mining permit, it sought to prove that the project would have been able to move into production phase but for the actions of Respondent and claimed the fair market value of the project using Discounted Cash Flow (DCF) method. Respondent objected that use of an income-based measure of value, such as DCF, would
be highly speculative given that the asset was not a going concern and had no history of operations or profitability.
Arbitral Tribunal held that evidence presented by Claimant was insufficient to support their claim, that a hypothetical purchaser of the project would have been willing to pay a price based on DCF projections. It was unconvinced due to a lack of evidence that the project had the ability to produce profits. Bear Creek was awarded its sunk investment costs of US$18.2 million.
Similarly, in Clayton and Bilcon of Delaware Inc. vs. The Government of Canada (PCA Case No. 2009-04), in 2004 Claimants acquired a quarry in Nova Scotia to develop alongside a marine terminal. In 2007, the project failed its governmental Environmental Assessment (EA) so it could not proceed.
According to Claimants they were unfairly treated by the Government of Canada during the EA process and filed a claim under NAFTA for US$443 million in compensation for future profits over the life of the project (50 years). Respondent’s point was that the obtention of EA was not certain and that project may have failed anyway regardless of NAFTA breaches.
Arbitral Tribunal held that Claimant failed to prove there was sufficient certainty that EA would have been granted or that the project would have been economically viable. It awarded compensation for loss of opportunity estimated at US$7.0 million for costs incurred.
Predictability and stability of future cash flows
In five solar power cases against Spain, Arbitral Tribunals awarded compensation for lost future profits even if power plants did not have a long history of operations. In Eiser Infrastructure Limited and Energia Solar Luxembourg S.à.r.l vs. The Kingdom of Spain (ICSID ARB/13/36), Claimants requested compensation for loss in value of their investments in three Concentrated Solar Power (CSP) plants following a change in feed-in tariff incentives enacted by Spain in 2013. The plants had been operating since May 2012.
Claimants calculations were based on cash flows that would have been generated by CSP plants over their useful life (40 years according to Claimants) had the original incentive legislation been maintained. Respondent claimed that DCF method was not appropriate due to long time-period of projections (25 years according to Respondent) which made assumptions used in DCF model highly uncertain. Instead, Respondent
relied on Regulatory Asset Base (RAB) of the plants, i.e. cost of building and maintaining
the plants.
According to the Arbitral Tribunal, power stations have a relatively simple business model, producing electricity whose demand and long-run value can be analysed and modelled in detail based on readily available data. It also noted that plants were still in operation and concluded that Claimants could be compensated for lost future profits over a 25- year period.
Focus on the future
Few Tribunals have put emphasis on the future profitability of a project or business as opposed to their history. In East Mediterranean Gas S.A.E. v. Egyptian General Petroleum Corporation and Egyptian Natural Gas Holding Company and Israel Electric Corporation Ltd (ICC, 18215/GZ/MHM) the Arbitral Tribunal held:
“…[Respondent] has, additionally, raised an objection as to the accuracy of a DCF model, given the lack of record of [Claimant]’s profitability. The Tribunal sees no reason for concern. The important fact is not whether [Claimant] can prove its profitability in the past, but rather whether it is reasonable to presume that, were it not for [Respondent]’s wrongdoing, it would have obtained a foreseeable stream of income in the future…”
A similar approach is illustrated in Process and Industrial Developments Limited v. The Ministry of Petroleum Resources of the Federal Republic of Nigeria (January 2017). In this case, parties entered into a 20-year Gas Supply and Processing Agreement (GSPA) in 2010, whereby Nigeria would supply Wet Gas to P&ID (Claimant) which would process it in a newly-built facility and return it in the form of Lean Gas. Nigeria did not make necessary arrangements for the agreed supply of Wet Gas, including building necessary pipelines. In March 2013, Claimant treated this as a repudiation of the GSPA. By that date, Claimant estimated that it had invested US$40 million in the project, although it had not yet acquired land or built the facility.
The claimant estimated that the project would produce a net profit of US$5 billion to US$6 billion over a 20-year period. Respondent objected stating that Claimant is only entitled to nominal damages as it had not fully performed its obligations under GSPA on the date of repudiation. Respondent insisted that damages could only be awarded for a period of three years as Claimant had a duty to mitigate its loss and should have
pursued other investment opportunities.
Despite repudiation occurring at a very early stage of the contract, the Arbitral Tribunal held that was no evidence that Claimant would not have performed its obligations if Wet Gas was supplied. In other words, in a but-for scenario, evidence indicated that Claimant would have been able to operate a profitable business, and lack of past operating history was not a decisive factor for Arbitral Tribunal in the circumstances. It awarded full compensation over the full length of the contract, so US$6.6 billion before interest.
In conclusion, it can be said that these cases illustrate the approach of Arbitral Tribunals to decide whether Claimants should be compensated for their future profits or only for costs already incurred. As can be seen, Arbitral Tribunals focus on evidence supporting the ability of a project or business to produce future profits rather than on their past performance and rely heavily on the particular facts of each case.
The author is an advocate practicing in the High Court of Madras.
Members of the Nani Palkivala Arbitration Arbitration Centre (NPAC) will be writing a weekly column for Bar & Bench analyzing the latest developments on the law of arbitration.