Round 1 Shallow Water Contracts & Nightmare Compliance Provisions

The Secretary of Energy (SENER) and National Hydrocarbons Commission (CNH) released draft contracts and other information related to the Round 1 bidding on shallow water projects.

Round 1 Basics

Here is a map of the shallow water locations up for bidding:

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The Round 1 process will take place over the next 8 months, ending in August. Here is a timeline (only in Spanish)

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Compliance Provisions 

The model contracts contain compliance provisions on anti-bribery and conflict of interest. Here are the compliance provisions (SENER’s unofficial English translation):

ARTICLE 32. ANTI-BRIBERY AND CONFLICTS OF INTEREST

32.1 Conduct of the Contractor and its Affiliates. The Contractor represents
and warrants that it and its Affiliates directors, officers, advisers, employees and personnel have not made, offered or authorized, and will not make, offer or authorize at any time any payment, gift, promise or other advantage, directly or through any other Person, for the use or benefit of any public official or any political party, official of a political party or candidate for any political office, for the purpose of: (i) influencing any decision or omission by a public official, political party or candidate, (ii) obtaining or maintaining this Contract or any other business, (iii) approving any Recoverable Cost, or (iv) ensuring any other illegal benefit or advantage for the Contractor, its Affiliates, its shareholders or any other Person. Furthermore, the Contractor shall ensure that it and its Affiliates (a) will conform to and comply with any anti-bribery laws and regulations applicable to them and (b) will establish and maintain adequate internal controls for compliance with the terms of this Article 32.1.

32.2 Notice of Investigation. The Contractor shall notify CNH and any other
competent Governmental Authority: (i) immediately upon becoming aware, or having sufficient reason to assume, that any act contravening the provisions of Article 32.1 has occurred, and (ii) within five (5) Days of gaining knowledge of any investigation or process initiated by any Mexican or foreign authority related to any alleged act that would violate the provisions of this Article 32. In addition, the Contractor shall keep CNH informed of the progress of the investigation and process through its conclusion.

32.3 Conflict of Interest. The Contractor agrees not to incur any conflict
between its own interests (including those of its shareholders, its Affiliates and the shareholders of its Affiliates) and the interests of the Mexican State in dealings with Subcontractors, customers and any other organization or individual that conducts business with the Contractor (including its shareholders, its Affiliates and the shareholders of its Affiliates) with respect to the Contractors obligations under this Contract.

Under Article 23(2)(i), the CNH has grounds for rescinding the contract if the contractor violates any of the compliance provisions in Article 32. If the contract is rescinded, the contractor loses its right to conduct petroleum activities in the area, must pay liquidated damages to the government (essentially equal to cost of completing the project), and loses the right to receive payments in relation to the contractor’s petroleum activities.

Significantly, companies acting as members of a consortium will face the same consequences if any one of the consortium’s members violates the compliance provisions.

Analysis of Impact

Anti-Bribery Commitments

The compliance provisions in the model contracts are interesting. The most striking characteristic is how broad they are. The representations and warranties about no improper payments does refer to the specific contract, but also includes ‘catch-all’ language that in principle applies to improper payments for any purpose. The Spanish language version could not be interpreted differently. It is unclear whether SENER intended to be so expansive with this provision. Most likely, they are more concerned with ensuring the integrity of the bidding process and the work performance for the contract.

Internal Controls Requirements

Similarly, the ‘internal controls’ requirement can be interpreted quite broadly. Contractors must ensure adequate controls are in place at its ‘affiliates’ (filiales), which is defined as “with respect to any Person, any other Person that directly or indirectly Controls, is Controlled by, or is under common Control with such Person.” So, Mexican subsidiaries of foreign companies must ensure adequate internal controls at its foreign parent and at other subsidiaries under that parent’s control? As for joint ventures or consortia where a company has a non-controlling interest, we already know that such a minority interest company faces joint liability if its partners violate the compliance provisions.

Notice of Investigation Obligation

The most striking provision is the ‘notification of investigations’ language. Generally, it requires a contractor to let the Mexican government – defined as CNH and ‘any other competent authority’ – know when: (a) it learns of potential violations of the compliance provisions; or (b) it is under investigation, either in Mexico or abroad, for conduct that would violate the anti-bribery provisions. In the latter case, the contractor has five days (!) to notify CNH and the mystery ‘competent authority’.

The first notification requirement – for ‘potential’ violations – is complicated by the same issues addressed above. Does a contractor need to notify CNH et al of any potentially improper payments, even those unrelated to the contract (e.g., what about small payments to traffic police)? Also, it is not apparent what would trigger a disclosure obligation on internal controls failures. More generally, the knowledge level that triggers the disclosure obligation – ‘becomes aware, or has sufficient reason to assume‘ – is vague and unhelpful. Although the latter sounds like the ‘willful blindness’ doctrine from the U.S., there it is applied in criminal and civil cases in order to define someone’s mental state in relation to an event that happened. Here, it is being used as a trigger for disclosure, even if it is not clear that something has happened.

The second notification requirement – on Mexican and foreign governmental investigations – is also flawed. Again, it would make sense if contractors only had to disclose investigations related to obtaining the contract and performing the work under the contract. As written, it constitutes an open-ended obligation to disclose to the Mexican government any anti-bribery investigation, from any country, of any of the contractor’s affiliates (i.e., parent and subsidiaries controlled by parent). Moreover, contractors are obligated provide updates to CNH on the progress of the investigation.

Problems with the Compliance Provisions 

In their current form, the compliance provisions in the model contract will result in one of three outcomes:

  1. Literally and conservatively interpreted, contractors will reflexively disclose every issue of potential concern to the CNH, making it impossible for the CNH to do its job
  2. Liberally interpreted or ignored, all contractors will face potential rescission, the likelihood that some contractors will make improper payments goes up, and the CNH is not alerted to serious compliance issues
  3. Many contractors – particularly big multinational companies – will refuse to accept the provisions as written, and will either forego participation or SENER will rewrite the provisions on a case-by-case basis, which will undermine the perception of their fairness (leading back to scenario no. 2)

In other words, the current compliance provisions will almost certainly defeat the very purpose they are intended to serve. The conflict of interest provisions – which are just as awful – reinforce this conclusion.

How to Fix the Compliance Provisions

Thus, SENER should revise the compliance provisions to ensure that they are reasonable, practicable, clear, and applicable to all. To meet these goals, SENER should:

  • Limit the definition of affiliates to companies controlled by the contractor
  • Limit the anti-bribery representations and warranties to conduct reasonably related to (a) obtaining the contract; or (b) performing work under the contract.
  • Either eliminate the internal controls requirement or put it into a new, stand-alone section, which defines ‘internal controls’. Also, internal controls failures should not trigger the notification obligation, and rescission for internal controls failures should be limited to cases of intentional, repeated, or severe violations; contractors should have the opportunity to resolve normal failures without losing the contract
  • Better define/explain the knowledge requirement – ‘sufficient reason to assume’ – for the disclosure obligation
  • Limit the disclosure obligation for government investigations to investigations by the Mexican authorities, or any other investigations – in Mexico or abroad – into conduct specifically related to obtaining and performing the contract
This entry was posted in CNH, compliance, corruption, energy, fdi, oil and gas, Pact for Mexico, pemex, procurement, reform, SENER. Bookmark the permalink.

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