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When is a contract not a contract?

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May 09, 2006 18:24 IST

There is a sense of déjà vu about the unraveling Iran LNG deal, which came about at the initiative of India's then petroleum minister Mani Shankar Aiyar in January last year.

The contract was signed by India's GAIL (Gas Authority of India Limited) and Iran's NIGEC (National Iranian Gas Export Company). The latter, a subsidiary of NIOC (National Iranian Oil Company) was to supply 5 million tonnes of liquefied natural gas to India for 25 years from 2009 at a price of US $3.21 per Million British Thermal Units, or MMBTU.

Now Iran says the contract was never ratified by its Supreme Economic Council, which is required before it can be placed before the NIOC board for approval. Without NIOC approval, the contract cannot be honoured.

Iran's turnabout may have been prompted by its desire to take advantage of the rising crude prices to bargain for a higher LNG price than that envisaged by the contract with India.

India-Iran $22-bn LNG deal in peril

But this development raises many other pertinent and disturbing questions.

First, there seem to be differing interpretations of the validity of the contract itself. How can a written contractual agreement between two legal entities be so vague as to lend itself to two opposing interpretations?

Whether the circumscribing clause which made the validity of the contract contingent upon approval by the NIOC Board -- which in turn was subject to the blessings of the Supreme Economic Council of Iran -- is part of the contract itself is the pertinent question.

If indeed it is, then the Iranian position that the contract is not binding has substance. If on the other hand, it is not part of the contract itself, but the requirement arose when a new government was installed in Iran after the elections, then these are uncertainties that international commerce will have to learn to live with.

Why Aiyar lost petroleum ministry

Visiting Iranian Deputy Oil Minister Mohammad Hadi Nejad Hosseinian insists that the contract needed ratification by the Supreme Economic Council in order to become effective, implying that the conditionality was part of the contract itself. This is also confirmed by India's petroleum ministry officials.

In that case, GAIL was not just aware of the clause, but was even a party to it. Why then did GAIL go for contingent contract with a company that was not fully competent to sign the contract?

Herein lies a lesson for our public sector companies -- as well as the Indian government -- entering into contractual agreements in the international arena. Entering into a contingent contract wherein we have firmly and irrevocably committed to our side of the bargain while the commitment of the other party is contingent upon some event occurring or not occurring puts us in a disadvantageous and vulnerable position.

This is not the first time we have done this. We did something similar when we signed the India-US Nuclear Deal wherein our commitments were sovereign, firm and irrevocable, while the American government commitments were subject to approval by the US Congress.

The Nuclear Tango

Caution needs to be exercised when entering into contractual agreements with a party which does not have full competence to make commitments under the contract.

The second issue is about open-ended agreements without a firm deadline.

We have seen this in the case of the RIL-NTPC gas supply agreement wherein NTPC issued a Letter of Intent to source gas from RIL, after the latter won an international competitive bid for the same. But there was no time-limit for entering into a firm contract and there was no clause which said that the offer itself would be automatically valid/invalid if a firm contract was not signed by a designated date.

Consequently, RIL chose to opt out of the contract, once again for similar reasons as in the case of NIGEC.

India very much part of pipeline: Iran

Here is lesson number two. Entering into open-ended contracts with an indefinite time-frame defeats the very purpose of the contract. Did the India-Iran LNG deal have a time-frame by which the approval of the NIOC Board would have to be obtained? What were the penalties for undue delay? If there were none, does India then wait indefinitely for the Iranian Supreme Council to finally make up its mind on the the matter?

GAIL is reportedly mulling legal options to resolve the issue. The contract provides for arbitration, but if GAIL has indeed signed a contingent contract, there is little hope of getting an award in its favour. At best, NIGEC may have to pay a penalty to exit from the contract which it claims is invalid anyway.

It would be foolish to expect the award, even if it goes in GAIL's favour, to actually compel Iran to perform the contract -- in letter and spirit -- and go on supplying gas for the next 25 years at the agreed price. Many ways and means can be devised to frustrate performance of the contract.

August deadline set for India-Iran pipeline pact

In the event, it would be in our best interests to avoid confrontation with Iran, but instead, focus on the pipeline proposal. After all, despite the advent of liquefaction technology, only 6 per cent of global gas trade is in the form of LNG. Pipelines from the neighbourhood continue to rule as the preferred transportation mechanism for gas.

And for India, of all the pipeline options, the Iran-Pakistan-India pipeline is perhaps the most promising, provided UN sanctions don't materialise. As for the goofed-up LNG contract, it should be treated as a learning curve cost and the lessons internalized for the future.

Sudha Mahalingam is a Senior Fellow at the Nehru Memorial Museum and Library, New Delhi

Sudha Mahalingam