Tanzania contract breach case highlights institutional weakness
When an energy investment appeared to be in danger in Tanzania, undermined institutions imperilled it further and instigated a breach of contract involving expropriation and discrimination at the expense of foreign investors.
Situation Report
On 15 October, the World Bank's court for investment disputes published its judgement that went against Tanzania in a breach of contract case involving the country and Standard Chartered Bank (SCB) Hong Kong. The subject of the arbitration was an energy deal made in 1995 involving state-owned Tanzania Electricity Supply Company (TANESCO), Independent Power Tanzania (IPTL), and a group of Malaysian lenders succeeded by SCB Hong Kong. The arbitration court found Tanzania culpable for expropriating IPTL and dishonouring a guarantee for power supply. The court ordered Tanzania to pay USD185 million to SCB Hong Kong as compensation.
Background
In 1995, Malaysian firm Mechmar partnered with Tanzanian firm VIP Engineering and Marketing to form IPTL to develop a new 100MW diesel-fired power plant in Tanzania. IPTL then signed an agreement with TANESCO to supply power to the utility for an initial 20 year-period. IPTL also signed a separate deal with the Tanzanian government, which undertook not to expropriate the company’s assets and guaranteed that it would pay IPTL any fees that the state utility owed the firm based on the power supply agreement. To finance the project, IPTL approached Malaysian banks for a USD105 million loan covered by a security deed and a share charge agreement.
By 2000, however, the power plant had not produced a watt of electricity and Tanzania had gone to arbitration with claims that IPTL had overpriced the facility and its services. The International Centre for Settlement of Investment Disputes (ICSID) ruled in Tanzania's favour and revised the charges downward. Mechmar and its local partner VIP disagreed on who should bear the shortfall and VIP eventually pursued domestic litigation to wind up the joint venture.
While that litigation was underway, the power plant had become operative. However, TANESCO began to delay payments and question IPTL's tariff charges. The state utility went back to arbitration in 2004 claiming that IPTL was overcharging for the power supply. Both IPTL and TANESCO then agreed to keep subsequent payments in an account escrowed at the Bank of Tanzania pending the outcome of the latest arbitration.
Back in Malaysia, the original lenders had undergone corporate restructuring amid litigation and regulatory action. The chief creditor who emerged from that restructuring, Danaharta, had also sold the loan and related security to SCB Hong Kong for USD76 million. As of 2007, SCB Hong Kong had succeeded the original lenders in their loan contract with IPTL, the power purchase deal with TANESCO and the guarantee agreement with the Tanzanian government.
Meanwhile in Tanzania, two Tanzanian businessmen named James Rugemalira and Harbinder Sethi were working to take over IPTL. Sethi had entered into the venture by purportedly acquiring Mechmar's 70% stake in the joint venture through a newly registered British Virgin Islands entity. Sethi had also acquired VIP's stake through its principal Rugemalira, such that PAP, a separate firm linked to the two businessmen, began to claim ownership over IPTL and its power plant. SCB Hong Kong was excluded from those arrangements. Nevertheless, a Tanzanian court authorised Sethi/PAP as the new IPTL owner.
In what was later known in Tanzania as the escrow scandal, Sethi/PAP then began directly receiving funds from that escrow account that was created at the Bank of Tanzania to hold funds payable to IPTL pending an ICSID arbitration. By the time that same arbitration was complete in 2014, the escrow account had been emptied.
The following year, SCB Hong Kong separately sought arbitration at ICSID against the Tanzanian government for breach of contract. Meanwhile, a parliamentary probe had taken place, which found that Sethi and Rugemalira had bribed judges and other senior government officials to corner the escrow funds. The indicted attorney general and energy minister resigned, and the two businessmen were arrested in 2017.
Breach of contract
Ultimately, in the ICSID case between SCB Hong Kong and the Tanzanian government, the investment court judged that it amounted to discrimination and expropriation when government agents ignored SCB Hong Kong's interest in domestic litigation and disbursed the escrow funds to an entity other than the investor, and that the government failed to provide security when it did not replenish the depleted escrow account.
Outlook
IPTL’s operational license in Tanzania expired in 2017 and authorities have declined to renew it. There are also ongoing investments to phase out emergency power schemes similar to IPTL, develop natural gas resources and expand infrastructure to improve delivery. One example is the 542km Mtwara-Dar es Salaam gas pipeline that was completed in 2017.
However, the institutional lapses that led to contractual breaches in this IPTL-SCB Hong Kong case have mostly not been addressed. In that case, Tanzania initially took steps to avoid breaches and resolve disputes according to the terms of contract, but deviated as key government institutions were subverted amid a scramble for the firm's ownership. Further, the parliamentary probe of the 2014 escrow scandal was not followed by reforms to strengthen the procurement system and improve transparency at institutions such as the central bank and judiciary. It indicates that the institutions remain prone to corruption, and authorities continue to be likely to act discriminately in disputes involving local and foreign parties, favouring local parties at the expense of foreign ones.
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