On 19 October 2016, Clyde & Co presented to an audience of oil and gas clients on legal issues relevant to entering into frontier markets, including Iran. A variety of legal risks and tips on how to manage them were identified. We have provided below a summary of the key points from the seminar.
CONSIDERATIONS FOR FRONTIER MARKET ENTRY
Foreign direct investment
Jonathan Silver, Clyde & Co's MENA managing partner, led a session on establishing new businesses in frontier markets. Jonathan discussed the increased risk of investing in emerging markets and some of the critical issues that need to be addressed, including:
- type and location of corporate entities;
- foreign ownership restrictions;
- issues relating to choosing business partners; and
- corporate taxation regimes across MENA.
In particular, there was a discussion regarding Iran's foreign ownership laws and taxation regime as compared to other MENA jurisdictions such as the Gulf Cooperation Council (GCC) countries.
Jonathan explained how important effective due diligence is when investing in new markets, for the purposes of identifying relevant risks and devising effective risk management or allocation mechanisms. Comprehensive due diligence on local partners is essential to discover the local partners' ultimate beneficial owners and to ensure that such owners are not politically exposed persons or connected to sanctioned entities, such as the Islamic Revolutionary Guard Corps in Iran.
Jonathan addressed strategies for the protection of investments; a key consideration for investors in frontier markets. Two such strategies are using special purpose vehicles to ring-fence liabilities and structuring investments to take advantage of favourable bilateral investment treaties. Some of the key concerns for foreign investors in frontier markets relate to whether local laws will be applied consistently to foreign investments and their ability to enforce their rights against domestic parties and state agencies. Bilateral investment treaties provide investors with assurances of non-discriminatory treatment and a reliable forum for resolving disputes. Local investment laws may also provide some level of comfort for investors although legal due diligence is still necessary to ensure such laws apply to investments in the oil and gas sector.
Investors also need to bear in mind laws and regulations dealing with regulatory, compliance, employment, intellectual property, and agency and distributorship arrangements. Several of these issues were addressed in more detail during the course of the seminar.
Upstream contracts in the MENA region
Richard Devine, head of MENA oil & gas, gave an overview of the market entry considerations for investors in the upstream oil and gas sector including the applicable legal environment and the terms of the upstream granting instrument. Richard addressed the two principal regimes that govern the way in which companies are granted the right to explore for and produce hydrocarbons: the royalty and tax regime and the production sharing regime. The production sharing regime is common in frontier markets and is used in a number of countries, including Egypt, the Kurdistan Region of Iraq, Libya, Oman, Yemen, Iran and Federal Iraq (in the form of a risk service agreement).
As an illustration, Richard compared the terms of the production sharing contract used by the Kurdistan Regional Government (KRG) and the Iran Petroleum Contract (IPC). In spite of the similarities of conditions in the two jurisdictions in terms of geology and political risk, the approach of the host governments has been quite different.
The KRG adopted a conventional production sharing arrangement whereby, if commercial quantities of oil and gas are discovered and developed, the Contractor receives cost oil or gas to compensate it for approved expenditures on Petroleum Operations and a share in the balance (profit oil or gas).
- The KRG has a carried interest and the right to acquire a further participating interest but does not participate through a national oil company.
- The KRG guarantees the stability of economic and fiscal conditions.
- The contract is governed by English law and disputes are generally subject to international arbitration.
The terms of the IPC have not been publicly disclosed. However, on 3 August 2016 Iran's Council of Ministers passed a regulation governing the general conditions, structure and terms of upstream oil and gas contracts (the IPC Regulation). The IPC Regulation provides for three types of IPC: a contract for exploration, development and production; a contract to develop existing discoveries; and a contract for improved/enhanced oil recovery at existing fields.
- The parties to each IPC will be the National Iranian Oil Company (NIOC) and a consortium of oil companies (which must include one of eight pre-qualified Iranian companies).
- The Contractor will recover its costs and will be compensated by a service fee only if petroleum operations are successful.
- The Government provides no guarantees to investors.
- The IPC will be governed by Iranian law and it is not known if disputes will be subject to international arbitration.
Richard discussed the importance of focusing not only on the terms of the relevant contracts, but also the legal environment and risks that could impact upon oil and gas investments.
Structuring employment arrangements in frontier markets
Ben Brown, a senior associate in Clyde & Co's employment practice, discussed the need for investors to consider local labour law requirements and immigration and sponsorship issues to ensure that they are able to adequately resource their operations on the ground.
Some GCC jurisdictions impose quotas on the number of nationals that must be employed in a business. Ben explained that in the Kingdom of Saudi Arabia the Nitiqat system penalises those employers who fail to meet Saudisation targets by, for example, increasing the cost of obtaining visas for expatriates. Whilst Iran does not impose specific quotas, it is the stated aim of the Iranian government to reduce unemployment among Iran nationals. To help achieve this, work permits will only be issued to expatriates if the expatriate's sponsor in Iran can show that:
- there is a lack of relevant expertise for their particular role among Iranian nationals;
- the expatriate is suitably qualified to fulfil their role; and
- the expatriate will use their expertise to train an Iranian national to eventually assume their role.
Ben also discussed the importance of investors being aware of the potential difficulties facing employers in dismissing employees in frontier jurisdictions, which often have employee-friendly labour laws. For example, in Iran employers are not permitted to dismiss an employee summarily (i.e., without notice) for gross misconduct and there is no cap on compensation for unlawful terminations. Investors will also need to understand their social security/tax obligations and the rules relating to the accrual of statutory end of service benefits in order to be able to assess the potential cost of resourcing into a particular jurisdiction.
Many international companies who send expatriate employees to work in frontier markets will do so under a dual employment arrangement (i.e., during the employee's assignment in the particular frontier market they will continue to be employed under an employment contract in the company's host country). Investors should be aware of the implications of dual employment arrangements and should ensure that such arrangements are documented carefully to reduce the risk of an employee inadvertently double recovering contractual and statutory entitlements in multiple jurisdictions.
Strategies for identifying and protecting valuable IP assets in R&D and the supply chain
The presentation was given by partner Rob Deans and Carl Fennessy, an associate in Clyde & Co's IP practice. Rob began by explaining the value of IP to a company's balance sheet before giving an overview of the trade mark issues relevant to oil and gas companies in the MENA region such as the use of regional sub-brands and slogans, Arabic translations and Arabic transliterations. Rob recommended protecting English and Arabic marks separately. The importance of clearance searches and the enforcement of IP rights in the MENA region were discussed.
Carl talked about copyright in works which include computer software, photographs, drilling reports and architectural works. Copyright protection is territorial and the applicable laws in the MENA jurisdictions differ from other jurisdictions such as the UK and USA. In particular, under regional laws typically the person creating the work (such as an employee or a person commissioned to create the work) owns copyright to works that they have produced unless the copyright in such works is expressly assigned to the employer/commissioner. Therefore, employment terms and commissioning contracts should be carefully drafted.
Carl addressed regional laws applicable to patents and know-how which are of particular importance to the oil and gas industry. Companies can protect their IP assets by formulating regional IP policies and including appropriate terms in their contracts of employment and other agreements such as commissioning agreements, joint venture, R&D and project agreements.
Effective approaches to compliance, anti-bribery and corruption
Patrick Murphy, a partner in Clyde & Co's dispute resolution group, talked about why it is important to have an effective compliance and anti-bribery and corruption policy:
- the global reach of regulators, targeting of senior management;
- liability for not having appropriate policies;
- severe penalties;
- high costs of investigations and remedial policies; and
- negative adverse publicity.
The MENA region and the oil and gas sector both rank as high risk and therefore compliance issues should be at the forefront of the investors' minds. MENA is still a significantly sanctioned region (Iran, Sudan, Syria, non-state actors) and employees, directors and officers from US and EU have higher compliance burdens than others.
Patrick gave an overview of the US Foreign Corrupt Practices Act 1977 and the UK Bribery Act 2010, and the differences between the two. Two recent cases were used to illustrate how the approach taken by a company to its offence can affect the willingness of the Serious Fraud Office (SFO) to prosecute.
The SFO entered into the UK's first deferred prosecution agreement (DPA) with ICBC Standard Bank plc in December 2015. Under the DPA proceedings are instituted but are deferred on terms (e.g., payment of a penalty, compensation, implementation of a compliance policy). ICBC Standard Bank plc was able to secure a DPA because it had self-reported its offence as soon as it had learnt of it and had fully cooperated with the SFO.
On the other hand, the SFO considered a DPA to be inappropriate in the case of Sweett Group because the Sweett Group had sought to obstruct the SFO's investigation and had denied any wrongdoing.
One of the key takeaways from these cases is that it is important for companies to have in place and follow a robust compliance program and that evidencing a compliance culture (by admitting offences and cooperating with relevant authorities) is likely to lead to a more lenient penalty.
Patrick addressed the Joint Comprehensive Plan of Action in relation to Iran which removes most US secondary sanctions and EU nuclear sanctions, and provides commitments from EU and US not to reimpose their respective sanctions. Patrick concluded with some recommendations from a compliance perspective when doing business in Iran and other frontier jurisdictions: the importance of due diligence, the technology transfer risk, issues around payment and insurance and the possibility of 'snapback' of sanctions.
Advice on the best way to deal with disputes in frontier markets, including choice of forum and enforceability considerations
The panel consisted of David Leckie (Partner, Clyde & Co) and Slava Kiryushin (General Counsel (MENA), Lukoil International Services B.V.) with Christopher Mills, head of the MENA dispute resolution group, acting as moderator.
The panel discussed drafting of dispute resolution clauses, dispute resolution venues and enforcement issues in the MENA region. The panellists shared their experience in dealing with practical issues relating to dispute resolution and enforcement. In particular, they noted the advantages of using English law as the governing law of international contracts. The panellists observed that dispute resolution clauses are often treated as boilerplate and are not given as much thought as the operative provisions of the contract. However, getting the dispute resolution clause right is essential for the protection of the parties' rights. Contracts in the MENA region, due to the cross-border nature of the transactions and nationalities of the parties, can have dispute resolution clauses that provide for a well-established governing law applied by local courts. The challenges of applying a foreign law should not be underestimated.
The panellists concluded that parties can be creative when drafting dispute resolution clauses provided they have considered some important questions: who is likely to be sued; is the dispute resolution venue appropriate for the type and value of the contract; will there be difficulties in applying the governing law and, importantly, how easy would be to enforce an award.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.