Document Type : Research Paper

Authors

• Farhang Ganjedanesh ¹
• mehrab darabpour ²

¹ Ph.D. Candidate, Oil and Gas Law, Faculty of Law, Shahid Beheshti University, Tehran, Iran,

² Professor of Law, Faculty of Law, Shahid Beheshti University, Tehran, Iran,

Abstract

In project finance agreements, the investor, the contracting authority, and the lender all rely on the project's future revenues to achieve their economic objectives. This means that one of the greatest risks in such projects is the termination of the contract before the contractual objectives are met and the execution period ends. In fact, in project finance agreements, investors and lenders do not have the right to seek recourse from the contracting authority to recover the financial resources spent on the project. Furthermore, either the project’s assets are insufficient to recover their large-scale economic investments, or they belong to the contracting authority, preventing investors and lenders from claiming them to satisfy their demands. In this context, a contractual clause known as the "termination payment" is included in project finance contracts as a key risk management tool for premature contract termination. This clause applies in all three scenarios of contract dissolution: due to the contracting authority’s fault, the investor’s fault, or reasons beyond the control of both parties. This study focuses on describing and analyzing termination payments in cases where the investor is at fault, allowing the lender and investor to recover a specified portion of the financial resources spent on the project. Analyzing this contractual provision is significant because, under general contract principles, a breaching party is not entitled to claim damages resulting from its own fault. However, the termination payment clause provides the breaching party and its lender with a mechanism to compensate for losses in various ways. Given the exceptional nature of this clause within contract law, it is essential first to examine the underlying reasons for its inclusion in project finance agreements. The payment of a termination fee in cases of investor fault, while preserving the contracting authority’s right to termination, enables the investor and lender to recover some of their financial resources. In essence, this clause serves as a crucial mechanism for balancing the contractual and sovereign rights of the contracting authority with ensuring the repayment of costs incurred by investors and lenders, making it a vital tool for project risk management. Without such a clause, securing necessary funding from financial markets becomes extremely difficult or even impossible, or the cost of obtaining financial resources increases to the point where the project loses its economic viability. Following the justification for the termination payment clause, this study examines how the clause is structured and how the termination fee amount is calculated. A key concern for the investor, the contracting authority, and the lender is selecting the appropriate method for calculating the termination fee. This choice is critical for risk management and for protecting the interests of all three parties involved in the project finance agreement. On one hand, selecting an appropriate calculation method incentivizes the parties to avoid termination and complete the project. On the other hand, an unsuitable method could encourage parties to exploit termination opportunities for excessive and windfall profits rather than making efforts to execute or rectify the project. The three main methods for calculating the project termination fee in project finance agreements are the debt-based compensation method, the market value method, and the book value method. There is no universal rule for determining the most suitable calculation method for any project. Just as the provisions of project agreements and financing contracts vary based on each project's unique characteristics, the termination payment clause must also be tailored to the specific contractual framework of each project. However, fundamental principles can be established for properly structuring this clause. The method for determining the project termination fee should consider the stage at which the contract is terminated. The further the project has progressed, the greater the investor's and lender’s entitlement to receive a termination fee. Another key consideration is protecting the lender’s rights, especially since the lender typically plays no role in causing the termination. Additionally, the termination payment clause should be structured to reinforce the parties' commitment to continuing contract execution. If the chosen calculation method provides excessive profits to any party upon contract termination, it may incentivize termination and reduce their focus on project completion. Finally, this study specifically examines the application of the termination payment clause in oil and gas contracts. Managing this issue in the oil and gas industry is particularly complex due to the tension between the host government’s sovereign rights and the need to incentivize investment in energy projects. On one hand, the host government’s sovereignty requires full recognition of its ownership rights over energy resources. If a contract is terminated due to investor fault, no claims over the host government's oil and gas assets or future revenues should be accepted. On the other hand, given the significant capital investments required in the oil and gas sector, ensuring adequate returns for investors and their lenders is a crucial factor in attracting investment. Without this assurance, securing the necessary investment in these industries becomes impossible. To explore these challenges, this study includes a case analysis of Qatar’s Dolphin Gas Project, focusing on its gas extraction, sales, and transportation contracts. The findings indicate that in each category of upstream, midstream, and downstream contracts within the Dolphin Project, the management of termination risk due to investor fault follows distinct legal frameworks. These frameworks aim to strike a balance between the sovereign rights of the host government and the financial interests of investors and lenders.

Keywords

• project finance
• project risk management
• termination payment
• sponsor default
• compensation calculation method
• oil and gas projects

Main Subjects

• Private Law