This article was published on mylaw.net on April 4, 2011. The link is http://mylaw.net/Article/Change_of_control_and_the_Canoro_Resources_judgment/
The Production Sharing Contract (“the PSC”) has been at the centre of much discussion in the recent past, particularly in relation to the convoluted legal and regulatory wrangle surrounding O.N.G.C.’sopposition to Vedanta’s acquisition of Cairn India.
The Delhi High Court, in a recent decision in Canoro Resources v. Union of India (O.M.P. No. 514 of 2010, judgment dated March 7, 2011) reached some interesting conclusions in relation to interpretation of a PSC.
The facts are simple enough. Canoro Resources Limited (“Canoro”), a Canadian company, held sixty per cent of the Participating Interest (“PI”) in the Amguri Oil Field in Assam. (PI is essentially a party’s participation in the rights and obligations under the PSC, expressed as a percentage. Sixty per cent PI means that the holder is required to contribute sixty per cent of the total cost required for the development of the oil field and is entitled to sixty per cent of the petroleum extracted from the oil field).
Canoro entered into an investment agreement with MASS Financial Corporation (“MASS”) under the terms of which MASS eventually held a majority of the shares in Canoro. The Ministry of Petroleum and Natural Gas (“the MOPNG”) informed Canoro that it considered this a breach of the PSC and gave a notice for termination of the PSC.
Canoro filed a petition under Section 9 of the Arbitration and Conciliation Act, 1996 (“the Arbitration Act”) to restrain the Government of India (“GoI”) from acting under the letter of termination. The judgment, in fact, raises important questions on the Arbitration Act, in particular, whether the court was correct in determining on the merits of the termination where the party’s chosen method of dispute resolution was arbitration. However, that discussion is not the subject of this post.
The relevant sections of the PSC are below.
Article 29.1 states that:
“Subject to the terms of this Article and other terms of this Contract, any Party comprising the Contractor may assign, or transfer, a part or all of its Participating Interest, with the prior written consent of the Government.” (emphasis supplied)
Article 29.2 states that:
“In case of any material change in the status of Companies or their shareholding or the relationship with any guarantor of the Companies, the Company(ies) shall seek the consent of the Government for assigning the Participating Interest under the changed circumstances.” (emphasis supplied)
Article 35.1 is also relevant, and requires the contractor to “notify the Government of any material change in their status, shareholding or relationship of that of any guarantor of the companies, in particular, where such change would impact on performance of obligations under this contract.”
The crux of Canoro’s defence was that by allotting fifty-three per cent of its shares to MASS, there has been no transfer or assignment of the PI as contemplated under Articles 29.1 and 29.2 of the PSC. Under Article 29.2, consent is only required if the change in shareholding is accompanied by an assignment of the PI. Canoro also argued that because of the difference in wording of Articles 29.1 and 29.2, there is no requirement to obtain “prior written consent” of the GoI in case of Article 29.2. They further stated that even under Article 35.1, the requirement is of notification, and that too, in cases where the change in shareholding impacts the performance of obligations under the contract.
The GoI, on the other hand, argued that what cannot be done directly, cannot be done indirectly. If prior consent is required for direct assignment or transfer of PI under Article 29.1, then prior consent is also necessary for indirect transfer of the PI by change of shareholding.
The Court rejected Canoro’s arguments and held that:
“…there appears merit in the submission of the respondent that what cannot be done directly, cannot be permitted to be done indirectly. Direct transfer of Participatory Interest without the prior consent of the respondent is prohibited, so also indirect transfer, vesting of majority stake in the contractor/ party constituting the contractor, without prior consent of the respondent, cannot be permitted…”
“The material change in the shareholding itself constitutes an assignment of the Participating Interest”. (emphasis supplied)
The court also observed that the government does not give up its sovereign rights even under a contract and can always act to safeguard vital strategic interests.
The judgment raises several interesting points in relation to a government contract, specifically a contract in the nature of a concession for public infrastructure. While Canoro was on thin ice in arguing against the prior consent in view of the specific provisions of the contract, the judgment goes beyond mere contractual interpretation when it states that what cannot be done directly cannot be done indirectly, and that change of shareholding amounts to an indirect transfer or assignment of a licence or concession.
The important question is whether the court would have reached the same conclusion if the PSC did not make a reference to change in shareholding at all. Essentially, even in case of a concession agreement which only prohibits the transfer or assignment of the concession, but does not refer to a change in shareholding, would Government consent still be required for the transfer of shares of the concessionaire (a similar controversy arose in relation to the show-cause notice given to Peninsula & Oriental Ports (“P&O”) by the Gujarat Maritime Board (“the GMB”) in terms of the concession agreement that P&O had entered into with GMB. Dubai Ports acquired the shares of P&O and GMB had threatened termination of the concession agreement, despite P&O constantly maintaining that the concession agreement did not in any manner prohibit the transfer of shares of P&O).
The Canoro analysis affects several provisions, including, for example, Rule 37 of the Mineral Concession Rules, 1960, which prohibits the transfer of the mining lease by the lessee without the Central Government’s consent. Applying the Canoro ratio, it is unlikely that courts will entertain an argument that Rule 37 does not prohibit a transfer of shares of the lessee.
The court’s finding that a change in shareholding amounts to an indirect transfer or assignment suggests that in case of interpreting change of control clauses where the government is a counterparty, extreme caution is advisable.
The next important consideration is what if this case did not involve the government. In a commercial contract between two private companies, for example, would it be held that a change in shareholding amounts to automatic assignment of the contract? The answer, surely, is no, since the court does expound that the government, even after entering into a contract, retains its sovereign authority, and can act to protect the national interest. However, the court does not say whether MASS’ acquisition of a majority stake in Canoro did in fact affect national interest or public policy in any manner.
Finally, it is clear from the judgment that the PSC was “unhappily” drafted at places, which left significant room for ambiguity. Surely, the omission of the words “prior written” in Article 29.2 was unintentional. Was there a necessity to link the change in shareholding of the contractor to the assignment of the PI in Clause 29.2? Is there any logic for both Articles 29.2 and 35.1 to exist in the contract and if they do, why don’t they refer to each other? Convincing the government to accept a modification to the language of a contract is extremely difficult, even if the modification is eminently logical. What it does leave is room for ambiguity and courtroom conflict.