It’s time to renegotiate
Sanctity of contracts. This is probably an unexpected first line in an article advocating the need to renegotiate contractual arrangements however it is a very relevant consideration. Sanctity of contract refers to the principle that once a party enters into a contract, that party will honour its contractual obligations. This is a familiar mantra that is heard, particularly from host governments, as it is important that investors know that the government of a country where they are seeking to invest upholds the doctrine of the sanctity of contracts. Trinidad and Tobago has a stellar reputation in this regard and care must be taken not to tarnish that reputation; once it is gone it may take decades to regain. Upholding the doctrine of sanctity of contracts however does not mean that once entered into there can never be a change in contractual arrangements, rather the doctrine should influence the manner in which any party whether it is a government, a company or an individual approaches the other seeking change.
It goes without saying that the current oil and gas prices are placing a tremendous amount of pressure on contracts within the industry. Many of these contract are long term in nature and involve the investment of significant sums. Before entering into these contract, parties would have spent considerable time analyzing the economics of these projects however it is unlikely that any analysis done just a few years ago would have contemplated a low case scenario with today prices. This pressure is being felt throughout the industry and parties are struggling to comply with their contractual obligations. Parties need to actively analyze the options that may be available to them to renegotiate their current arrangements.
Given that we have established the need to preserve the sanctity of contracts, any strategy to renegotiate contractual arrangements should begin by a thorough review of existing contracts. The focus should be on determining whether there are any express or implied provisions which enable you to call upon the other party to renegotiate the terms of the contract. Some contracts have built in review mechanisms, many of which are related to price. These provisions may be quite detailed, setting out the circumstances which must exist and the timing and manner in which any pricing review or renegotiation is to be conducted. Others may be more general in scope, merely setting out the conditions that existed when the contract was entered into and providing for the parties to relook at the contract if there has been a material change in circumstances. In our current environment, it will not be difficult to argue that there have been material changes and thus parties should consider their ability to use any such provisions to initiate a renegotiation.
Where there are no such express or implied provisions, you may need a broader examination of not only the contract but also of how the contract is managed. You may need to consider whether you are properly enforcing all of your rights under the contract. It is not uncommon for contracts to be applied in a particular manner between parties which is not the correct application on a true interpretation of the terms of the contract. There may also be ambiguous provisions that have been treated in a particular manner that may need re-examination. Further, parties over time may not have enforced their contractual rights in respect of certain breaches. A detailed review of your contractual management system may reveal areas which may give a party useful levers to initiate a contractual renegotiation.
Once all of the above is considered and a strategy is being developed as to the manner in which a contractual renegotiation should be broached and the basis for the renegotiation, parties also need to consider, in the broadest sense, what are the commercial realities of all parties. What are you able to offer the other side; what do they need; what do you need; will any renegotiated position be temporary in nature; what are the conditions that will cause the parties to revert to the original position or to seek a new arrangement in the future; and in what other way can you seek to exercise any measure of leverage.
The current oil and gas prices have caused renegotiations to be undertaken throughout the global industry and the reality is that such renegotiations are required otherwise we may be faced with breaches of contracts, companies becoming insolvent and costly litigation. We are better off spending the time and energy trying to adjust to this current pricing environment. The reality is that we are all aware the some adjustment is needed and while you delay, your counterparty may be sitting by the phone waiting for your call.