June 17, 2016

1/3LY oil & gas disputes: Investing in Iran

Iran has attracted considerable interest in recent months following implementation of the Joint Comprehensive Plan of Action (JCPoA) in January 2016. The effect is a substantial (but by no means absolute) abolition of EU sanctions, together with a significant reduction in US secondary sanctions. Of course, US primary sanctions remain in place.

Investors and those intending to trade with Iran directly or indirectly are still faced with compliance issues, notably avoiding involvement with so-called "designated" or "specially designated nationals". There are also practical problems in arranging finance, handling payments and obtaining effective insurance.

The subject of this brief article is the issue of the governing law and forum for dispute resolution with Iranian counterparties. The importance of these aspects will depend upon the size of the transaction, its intended life and the methods by which payments are to be made. We consider mainly one scenario where a foreign/ EU counterparty is seeking to invest in Iran in a long-term project.

Memorandum of Understanding: Is it binding?

Following negotiations, it is often suggested by the Iranian counterparty, that the key aspects of the proposed contract are reduced to a Memorandum of Understanding (MOU). Invariably the MOU will contain a law and dispute resolution clause intended to cover the terms of the MOU and the final contract.

There is a difference between some investors as to how they view a MOU. Some see it as giving rise to binding obligations, subject to fulfilment of various conditions. However, many see it as a staging post (without binding obligations) to reflect the parties’ willingness to enter into a transaction proposed which will allow formal documents to be drafted and appropriate permissions to be obtained. It is also often seen as a precursor to extensive due diligence, both financial and legal, being undertaken.

In the MOU context there are two key questions:

  1. To what extent is it necessary to do due diligence prior to signing the MOU? It would be unwise to engage in a MOU without some degree of due diligence on the counterparty concerned. This is because the regulatory regime still prevents the passing of "funds" or "economic resources" to a designated person or entity. The words "funds" and "economic resources" are broadly defined. Accordingly, at this stage, due diligence is recommended on the counterparty. The MOU should make clear that any formalisation of the contract or position is dependent on the investor being satisfied that no sanctions violation would occur in any applicable law or jurisdiction. The MOU should, where practical, foresee the type of due diligence to be undertaken.
  2. Should the MOU be binding? To the extent that further due diligence is required including, for example, the employment of any local sub-contractors, it would be unwise, even in the current more relaxed sanctions regime to make the MOU binding, in our view. This is mainly due to regulatory concern and the considerable practical difficulties in dealing with EU financial institutions where Iranian business is concerned. There may, of course, be other commercial considerations which are relevant in this context.

Common law v civil law: Impications for MOUs

Under English law, a MOU would not be considered as binding if it was expressed as such. Without a clear statement, however, there is a risk that the MOU may be viewed as giving rise to legally binding obligations. Recent cases demonstrate the reluctance of the English court (and one would presume arbitration tribunals) to disregard MOUs as being "agreements to agree". In the 2010 "Muller" case1 the Supreme Court held that although "there was no formal contract, [the parties] did reach a legally binding agreement..." The Court held that the "moral of the story is to agree terms first and start work later."

Under other laws, particularly civil laws such as Swiss law, the MOU may give rise to obligations even if it is expressed to be non-binding. This could arise, for example, by reason of the implied obligation to exercise "good faith", the concept of which may prevent that party from withdrawing from the transaction without good reason.

Accordingly, at the MOU stage, consideration needs to be given to the governing law to understand the precise nature of the obligations, if any. Iranian law recognises the choice of a foreign law where one party is non-Iranian and the contracts providing for foreign law are signed in the country whose law is to govern the contract. Under Iranian conflict of law principles, the law governing the contract is the place of execution2.

Choice of Arbitration forum

The choice of the arbitration forum is not, in our experience, straightforward. Iranians have endured over the last decade or more, arbitrations and court actions in jurisdictions that they would have preferred to avoid. As ever in these situations, the emphasis for the foreign investor should be on a forum which is acceptable even though it is not necessarily the natural or preferred forum of the investor. Iranian law recognises the right to arbitrate outside Iran and Iran has ratified the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards.

But there are limitations to the arbitration route. First, there is no clear track record of enforcement under the New York Convention. Second, enforcement will, of course, be subject to public policy issues. There are local arbitration fora in Iran, namely the Arbitration Center of Iran Chamber and the Tehran Regional Arbitration Center but, with a near decade of sanctions, there is limited recent experience. In addition, arbitration agreements involving public or state property need parliamentary approval which will be difficult to obtain. Given this uncertainty, the parties may wish to consider, in appropriate circumstances, how they can secure their obligations outside Iran.

How to protect your investment

Foreign investment in Iran would ordinarily benefit from a license from the Organisation for Investment, Economic and Technical Assistance of Iran (OIETAI) in accordance with the Foreign Investment Promotion and Protection Act (FIPPA). This framework provides protection to foreign investors for non-commercial risk such as the right to repatriate profits and acts of expropriation by the government. Disputes under FIPPA are referred to the local courts unless the investor is based in a country with which Iran has a Bilateral Investment Treaty (BIT). In that event, the investor will have the option to refer any dispute against the State either to the local courts or to the arbitration forum provided in the BIT. The UK currently has no BIT with Iran (though one is apparently under negotiation) so a dispute of a political risk nature would have to be determined before the local courts.

There are currently over 50 BITs in force between Iran and various nations affording investors substantial protection. However, caution needs to be exercised in relation to these BITs. The term "investor" is generally expressed to mean those natural persons who, according to the law of the contracting state, are considered to be a national. This may have the effect of preventing BIT "forum shopping" where a company incorporated in a country which does not have the benefit of a BIT seeks to incorporate a subsidiary in a BIT investment state as a vehicle for investment in Iran and thereby gain the benefit of the BIT. There is another limitation. BITs with Iran make clear that the scope of the treaty applies only to investments approved by the competent authority of the hosting state and in the case of Iran, the competent authority is OIETAI. That being the case, it is unlikely that the benefit of the BIT will inure for the benefit of any investor which has not obtained such consent, though obtaining the approval of OIETAI would also provide other benefits in terms of local support and as a body which may help in the resolution of disputes.

Iran has its own idiosyncrasies in terms of legal requirements and its isolation for so many years has deprived it of experience from which investors can gain comfort. Careful consideration needs to be given both to the choice of law and the means by which disputes are resolved and this needs to be done at an early stage before a MOU is signed. That said, it is undoubtedly true that Iran, described as the "last great frontier", offers tremendous opportunities for foreign investors.

1RTS Flexible Systems Limited v Molkerei Alois Muller Gmbh & Company KG (UK Production) [2010] UKSC 14

2Article 968 of the Civil Code states that "obligations arising out of contracts are subject to the laws of the place of execution of the transaction except in cases where the parties to the contract are both foreign nationals and have explicitly or impliedly declared the transaction to be subject to the laws of another country".