O.M.P. No.528/2010 Page 1 of 44 19 * IN THE HIGH COURT OF DELHI AT NEW DELHI Judgment reserved on: 07.09.2010 % Judgment delivered on: 09.11.2010 + O.M.P. No.528/2010 & I.A. Nos.11839/2010 & 11861/2010 UNION OF INDIA ..... Petitioner Through: Mr. A.S. Chandhiok, ASG with Mr. R. Sasiprabhu & Mr. Ritesh Kumar, Advocates versus SELAN EXPLORATION TECHNOLOGY LTD. ..... Respondent Through: Mr. Neeraj Kishan Kaul, Senior Advocate with Mr. S. Rewari & Mr. Prashant Kalra, Advocates CORAM: HON’BLE MR. JUSTICE VIPIN SANGHI 1. Whether the Reporters of local papers may be allowed to see the judgment? : Yes 2. To be referred to Reporter or not? : Yes 3. Whether the judgment should be reported in the Digest? : Yes J U D G M E N T VIPIN SANGHI, J. 1. The petitioner, Union of India, has filed this petition under section 34 of the Arbitration and Conciliation Act, 1996 (the Act) to seek the setting aside of the arbitral award dated 03.05.2010 passed O.M.P. No.528/2010 Page 2 of 44 by the arbitral tribunal consisting of Dr. Justice A.S. Anand, Former Chief Justice of India, Mr. Justice S.S. Sodhi, Former Chief Justice of Allahabad High Court and Mr. Justice J.K. Mehra, Former Judge of Delhi High Court. 2. The award is a unanimous award rendered by the arbitral tribunal, whereby the arbitral tribunal has interpreted Article 14 of the Production Sharing Contract (PSC) between the parties. The tribunal has accepted the interpretation advanced by the respondent, and rejected the interpretation advanced by the petitioner. 3. First, the back ground facts. In or around 1992, the Government of India decided to attract private investment in the sector of exploration and production of petroleum. It issued a notice inviting tender and invited bids in respect of certain oil fields from the private sector. 4. The respondent, in response to the NIT, submitted its bid. The bid also contained the respondents proposal for profit sharing of the petroleum. The respondent projected an investment of Rs.2.70 crores in the Lohar Block for carrying out petroleum operations in two phases, i.e. to carry out the detailed 3-D Seismic Survey to be followed by one or two extension wells and to carry out work from the existing well for production of petroleum. 5. After extensive negotiations, the parties entered into the PSC O.M.P. No.528/2010 Page 3 of 44 dated 13.03.1995. The production of petroleum in the Lohar Oilfield was started by the respondent in 1995-96. The formal mining lease was granted by the Govt. of State of Gujarat in favour of the respondent on 10.10.2003 with effect from 13.03.1995 in the area admeasuring 5.00 sq. kms in Lohar Block of Mehsana District for 25 years. 6. The recitals in the PSC read as follows: “(1) The Oil Fields (Regulation and Development) Act, 1948 (53 of 1948) (hereinafter referred to as “the Act”) and the Petroleum and Natural Gas Gules, 1969, made thereunder (hereinafter referred to as “the Rules”) make provision inter alia for the regulation of Petroleum Operations and the grant of licences and leases for exploration and development of Petroleum in India; (2) The rules provide for the grant of mining leases in respect of land vested in a State Government by the State Government with the previous approval of the Central Government. (3) Exploration carried out by the Oil and Natural Gas Corporation Ltd. prior to the Effective Date has led to a Discovery in the Contract Area, hereinafter referred to as the Discovery. (4) The Government desires that the Petroleum resources which have been discovered and may exist in the Contract Area be exploited with the utmost expedition in the overall interest of India in accordance with good petroleum industry practices. (5) Government had invited bids from persons interested in the development of petroleum resources in the Contract Area. (6) The Companies have represented that they have the necessary financial and technical resources O.M.P. No.528/2010 Page 4 of 44 and the technical and industrial competence and experience necessary for proper discharge and/or performance of all obligations required to be performed under this Contract in accordance with good petroleum industry practices. (7) The Government and the Company have agreed to enter into this Contract with respect to the area referred to in Appendices A & B of this contract on the terms and conditions herein set forth”. 7. A few definitions contained in the contract may also be referred to at this stage. “1.20 “Cost Petroleum” means the portion of the total volume of Petroleum produced and saved from the Contract Area which the Contractor is entitled to take in a particular period for the recovery of Contract Costs as provided in Article 13”. “1.38 “Investment Multiple” means, in relation to the Contract Area, the ratio of accumulated Net Cash Income from the Contract Area to accumulated Investment in the Contract Area, earned by the Companies, as determined in accordance with paragraphs 3-7 of Appendix D”. “1.41 “Net Cash Income” shall have the meaning assigned in paragraph 2 of Appendix D. “The “Net Cash Income” of the Companies from the Contract Area in any particular year is the aggregate value for the year of the following: (i) Cost Petroleum entitlement of the Companies as provided in Article 13; Plus (ii) Profit Petroleum entitlement of the Companies as provided in Article 14; Plus O.M.P. No.528/2010 Page 5 of 44 (iii) All incidental income (or the type specified in section 3.4 of the Accounting Procedure) arising from Petroleum Operations; less (iv) royalty and cess less (v) All Production Costs incurred on or in the Contract Area; less (vi) the notional income tax, determined in accordance with paragraph 7 of this Appendix, payable by the Companies on profits and gains from the Contract Area”. “1.53 “Profit Petroleum” means all Petroleum produced and saved from the Contract Area in a particular period as reduced by Cost Petroleum and calculated as provided in Article 14”. 8. Article 2 defines duration of the contract to be a period of 25 years from the effective date, unless the contract is terminated earlier in accordance with its terms. It is extendable by the Government for a further period not exceeding 5 years, provided that it may be extended for a further period, but not exceeding 35 years from the effective date. 9. Article 13 provides for recovery of contract costs by the contractor for extraction of oil and gas. Insofar as it is relevant, it reads as follows: “ARTICLE 13 O.M.P. No.528/2010 Page 6 of 44 RECOVERY OF COSTS FOR OIL AND GAS 13.1 The Contractor shall be entitled to recover Contract Costs out of the total volumes of Petroleum produced and saved from the Contract Area in accordance with the provisions of this Article, after deduction of applicable levies. 13.2 Development Costs incurred by the Contractor in the Contract Area up to the date of Commercial Production shall be aggregated, and the Contractor shall be entitled to recover out of the Cost Petroleum the aggregate of such Development Costs at the rate of one hundred percent (100%) per annum of such Development Costs beginning from the date of such Commercial Production from the Contract Area. 13.3 The Contractor shall be entitled to recover out of the Cost Petroleum the Development Costs which it has incurred after the date of Commercial Production from the Contract Area at the rate of one hundred percent (100%) per annum of such Development Costs beginning from the date such Development Costs are incurred. 13.4 The Contractor shall be entitled to recover in full during any Year the Production Costs incurred in the Contract Area in the Year out of the Cost Petroleum. If during any Year the Cost Petroleum is not sufficient to enable the Contractor to recover in full the Contract Costs due for recovery in that Year in accordance with the provisions of Articles 13.2 to 13.4 then : (a) recovery shall first be made of the Production Costs; and (b) recovery shall then be made of the Development Costs. The unrecovered portions of Contract Costs shall be carried forward to the following Year and the Contractor shall be entitled to recover such Costs in such Year or the subsequent O.M.P. No.528/2010 Page 7 of 44 Years as if such Costs were due for recovery in that Year, or the succeeding Years, until the unrecovered Costs have been fully recovered out of Cost Petroleum from the Contract Area. 13.5 The maximum percentage of Cost Petroleum to which the Contractor shall be entitled, in accordance with the provisions of this Article, shall be on hundred percent (100%) for initial Five (5) years and fifty (50%) thereafter”. 10. Article 14 is most relevant, and insofar as it is relevant, reads as follows: “ARTICLE 14 PRODUCTION SHARING OF PETROLEUM BETWEEN CONTRACTOR AND GOVERNMENT 14.1 The Contractor and the Government shall share in the Profit Petroleum from the Contract Area in accordance with the provisions of this Article. The share of Profit Petroleum, in any year, shall be calculated for the Contract Area on the basis of the Investment Multiple actually achieved by the Companies at the end of the preceding Year for the Contract Area as provided in Appendix D. 14.2 Profit Sharing 14.2.1 When the Investment Multiple of the Companies at the end of any Year is between zero (0) and three and a half (3.5), including three and a half (3.5), the Government shall be entitled to take and receive zero per cent (0%) and the Contractor shall be entitled to take and receive one hundred per cent (100%) of the total Profit Petroleum from the Contract Area with effect from the start of the succeeding Year. 14.2.2 When the Investment Multiple of the Companies at the end of any Year in respect of the Contract Area is more than three and a half (3.5) the O.M.P. No.528/2010 Page 8 of 44 Government shall be entitled to take and receive fifty per cent (50%) and the Contractor shall be entitled to take and receive fifty per cent (50%) of the total Profit Petroleum from the Contract Area with effect from the start of the succeeding Year. 14.3 For the avoidance of doubt, it is hereby stated that once the Companies‟ Investment Multiple has increased so as to trigger, in any Year, a higher percentage of Profit Petroleum sharing for the Government (and a lower percentage for the Contractor) than that existing before the date of such increase, the Parties shall be entitled to share in the total volume of Profit Petroleum in the proportions specified in the relevant Articles above in respect of the higher levels of Investment Multiple and shall not be entitled to receive any Profit Petroleum shares in respect of the lower levels of profitability. 14.4 The value of the Companies‟ Investment Multiple at the end of any Year in respect of the Contract Area shall be calculated in the manner provided for, and on the basis of the net cash flows specified, in Appendix D to this Contract. However, the volume of Profit Petroleum to be shared between the Government and the Contractor shall be determined for each Quarter on an accumulative basis. Pending finalization of accounts, delivery of Profit Petroleum shall be taken by the Government and the Contractor on the basis of provisional estimated figures of contract costs, production, prices receipts, income and any other income or allowable deductions and on the basis of the value of the Investment Multiple achieved at the end of the preceding Year. All such provisional estimates shall be approved by the Management Committee when it is necessary to convert monetary units into physical units of production equivalents or vice versa, the price or prices determined pursuant to Articles 18 and 20 for Crude Oil, Condensate and Natural Gas respectively shall be used. Within sixty (60) days of the end of each Year, a final calculation O.M.P. No.528/2010 Page 9 of 44 of Profit Petroleum based on actual costs, quantities, prices and income for the entire Year shall be undertaken and any necessary adjustments to the sharing of Petroleum shall be agreed upon between the Government and the Contractor and made as soon as is practicable thereafter.” 11. For the financial year 2005-06, upon calculation, it was found that the value of the Investment Multiple (IM) had increased to 5.16. The petitioner, therefore, invoked Article 14.2.2, as above extracted, and demanded 50% of the Profit Petroleum, from the year 2006-07 onwards. It appears, there is no dispute between the parties so far as the share of the petitioner in the profit petroleum for the financial year 2006-07 is concerned. However, for the subsequent years, i.e. 2007- 08 onwards, the respondent disputed the claim of the petitioner founded upon the IM of 5% achieved at the end of the financial year 2005-06. 12. The stand of the respondent in its letter dated 29.01.2007 was that since the IM did not exceed 3.5 in any quarter of the financial year 2006-07, therefore, sharing of Profit Petroleum would not become applicable in the financial year 2007-08 as per the provisions of Article 14.2 to Article 14.4 of the PSC. 13. The petitioner reiterated its stand vide email dated 08.02.2007, wherein it was contended that as per Article 14.2, 14.3 and 14.4 of the PSC, the contractor will have to pay 50% of the Profit O.M.P. No.528/2010 Page 10 of 44 Petroleum, if any, to the Government of India, with effect from the financial year 2006-07 irrespective of whatever the IM be, since the IM had exceeded 3.5 in the financial year 2005-06. 14. Consequently, disputes arose between the parties in relation to the interpretation of Article 14. According to the respondent it is only when the IM of the company exceeds 3.5 in a particular year, that the share of the petitioner in Profit Petroleum in the succeeding year would be 50%, but later on if the IM falls below the value of 3.5, in any year, the share of the petitioner in the profit petroleum would be 0% in the succeeding year. 15. On the other hand, the case of the petitioner before the arbitral tribunal was that once the value of IM exceeds 3.5 in any year, the share of the petitioner, in all subsequent years would be 50%, and the share of the respondent in profit petroleum shall, for the remaining period of the contract, get restricted to 50% of the profit petroleum. 16. The arbitral tribunal framed issues on 08.05.2009 after the pleadings were completed. On 17.08.2009, the arbitral tribunal deleted issue nos.3 to 6. The first 2 issues framed by the arbitral tribunal are relevant for the present purpose, and read as follows: “1. Is the Claimant entitled to retain entire Profit Petroleum for the financial year 2007-08, since the Investment Multiple did not trigger value higher than 3.5 in any quarter of the preceding financial year? 2. Is the Respondent entitled to receive 50% of the Profit O.M.P. No.528/2010 Page 11 of 44 Petroleum available for the year 2007-08 and for subsequent years, irrespective of the position that in the preceding financial year the Investment Multiple fell below 3.5 because in the financial year 2005-06 the Investment Multiple had triggered a value higher than 3.5?” 17. The arbitral tribunal in paragraph 74 of the impugned award held and declared as follows: “that Article 14.1, 14.2 and 14.3 when read together, mandate that the Investment Multiple actually achieved has to be calculated ever year to determine the share of Profit Petroleum in the preceding year, to be shared in the succeeding year in accordance with the scheme of Article 14.2.1 and 14.2.2. Thus, if, the IM exceeds the value of 3.5 in a particular preceding year, then for the succeeding year, the share of Profit Petroleum would be calculated as per Article 14.2.2 but, thereafter, if, in the immediately succeeding year or any subsequent year, the IM value falls below 3.5 in the concerned preceding year, the share of the Government in Profit Petroleum in the succeeding year, would be determined as envisaged by Article 14.2.1” 18. The submission of learned Additional Solicitor General, Mr. A.S. Chandhiok is that the interpretation advanced by the respondent and adopted by the arbitral tribunal goes contrary to the express terms of the contract. He submits that the present is not merely a case of interpretation of the contract by the arbitral tribunal, which would normally not be interfered with, in proceedings under section 34 of the Act. He submits that the impugned order is patently illegal. 19. Mr. A.S. Chandhiok submits that the arbitral tribunal has completely ignored Article 14.3 of the PSC which in unequivocal terms O.M.P. No.528/2010 Page 12 of 44 provides that once the respondents IM increased so as to trigger, in any year, a higher percentage of profit petroleum sharing for the Government (and a lower percentage for the respondent), “than that existing before the date of such increase, the Parties shall be entitled to share in the total volume of profit petroleum in the proportion specified in the relevant Articles”, namely Articles 14.2.1 and 14.2.2 “in respect of the higher levels of IM and shall not be entitled to receive any profit petroleum shares in respect of the lower levels of profitability”. (emphasis supplied) 20. Mr. Chandhiok submits that Article 14.3 is capable of one and only one interpretation, i.e. that if and when the respondent contractor achieves a level of profitability measured in terms of the IM more than 3.5 even once, then for the remaining term of the contract (which as per Article 2 is defined as 25 years from the effective date), the petitioner would be entitled to a “share in the total volume of profit petroleum” in the ratio fixed under Article 14.2 (which deals with profit sharing) “in respect of higher levels of Investment Multiple” and not in the proportion in respect of the lower levels of profitability. 21. Mr. Chandhiok submits that the PSC is structured such that the contractor is entitled to recover contract costs i.e. Development Costs and Production Costs from out of “the total volumes of petroleum produced and saved from the Contract Area”. Article 13.2 entitles the contractor to recover the aggregate of Development Costs incurred O.M.P. No.528/2010 Page 13 of 44 upto the date of Commercial Production out of the cost petroleum @ 100% per annum. Development Costs incurred after start of commercial production are recoverable from the cost petroleum @ 100% per annum. The contractor is entitled to recover its production costs in any year from the cost petroleum in that year. Cost petroleum could be 100% of the production in the first five years, and 50% of the production thereafter. He refers to Article 13 of the PSC in this respect. 22. I may note that the understanding of the petitioner, as aforesaid, also appears to have been the understanding of the respondent as is evident from paragraph 35 of the impugned award. However, the claim of the respondent that the initial five years should be taken to commence from 10.10.2003 (the date of grant of the mining lease) and not from September 1995, (when the Government of the State of Gujarat had agreed in principle for grant of mining lease for, inter alia, the area in question) was rejected by the arbitral tribunal. Reference in this regard may be made to paragraphs 45, 46 and 52 of the impugned award. 23. In paragraph 47 of the award, the arbitral tribunal held as follows: “The basic aim of Article 13.5 is, thus, to allow the contractor to recover its Development Cost from the revenue of Petroleum produced in the initial five years at the rate of 100% of the Contract Costs without the Government getting any share in those five years. O.M.P. No.528/2010 Page 14 of 44 Thereafter, share of the Claimant in the Contract Cost would be at the rate of 50% of the Cost Petroleum and the balance 50% shall be received and taken by the Government. Article 13.5, thus, allows the Contractor to recover Development Costs at the rate of 100% for the „initial five‟ years out of the Cost Petroleum and thereafter to share it in the ratio of 50:50% with the Government”. 24. Mr. Chandhiok submits that the determination of the IM under Article 14.1 was relevant for the purpose of determining the share of the parties in the profit petroleum under the PSC. The share of the petitioner in the profit petroleum, in any year, was to be determined by reference to the IM actually achieved by the respondent at the end of the preceding year as provided in Appendix D. He submits that since, in the initial five years of commercial production, the entire production could be allocated as cost petroleum to recover Development Costs and Production Costs, and thereafter the cost petroleum could be upto 50% of the production in any year, the IM was required to be calculated year after year so that the profit petroleum (i.e. all the petroleum produced minus the cost petroleum) could be shared in the proportion set out in Articles 14.2.1 and 14.2.2. However, Article 14.3 clarified the matter beyond any doubt that “once” the respondents IM had increased “so as to trigger” in any year, a higher percentage of profit petroleum sharing for the Government and, consequently a lower percentage for the respondent than that existing before the date of such increase, then thereafter the parties were entitled to share the O.M.P. No.528/2010 Page 15 of 44 “total volume of profit petroleum” in the proportion specified in the relevant Articles of Article 14 in respect of the higher levels of IM, and the Government was not to receive any profit petroleum in accordance with the lower levels of profitability. He submits that the use of the expressions “once”, “trigger” and “total volume of profit petroleum” clearly show that the once the milestone of IM greater than 3.5 had been achieved, (as provided in Article 14.2.2, which entitles the Government to take and receive 50% of the profit petroleum and which reduced the respondent/contractors share to 50% of profit petroleum for the succeeding year), the share of the Government for the remaining period of the contract in the total profit petroleum would have to be determined by reference to the share prescribed in respect of the higher levels of IM and shall not be reduced in respect of the lower levels of profitability, i.e. for IM lower than or equal to 3.5. 25. Mr. Chandhiok submits that the purpose of the contract was to provide for the mechanism of profit sharing between the parties, of the profit petroleum mined by the respondent/contractor. The determination of the IM on an annual basis was merely a statistical and academic exercise, since the profit sharing was linked to the IM achieved in a given year so as to determine the shares in the profit petroleum in the subsequent year. It did not mean that even after the milestone of IM more than 3.5 had been achieved, the exercise of determining the IM was required to be undertaken for the purpose of O.M.P. No.528/2010 Page 16 of 44 fixing profit sharing ratio for the remaining term of the contract. 26. Mr. Chandhiok submits that the interpretation advanced by the respondent, and adopted by the arbitral tribunal, was in the teeth of Article 14.3. He submits that the perusal of the impugned award shows that the arbitral tribunal has not once considered the effect of the words “… … and shall not be entitled to receive any profit petroleum shares in respect of the lower levels of profitability”. He submits that the arbitral tribunal has skirted the issue that arose before it, by completely ignoring the clear mandate of Article 14.3 of the contract. 27. Mr. Chandhiok further submits that the arbitral tribunal while rendering its award has not only ignored the mandate of Article 14.3, but