Pertamina obstinacy does Indonesia no favours

State-owned oil giant continues three-year appeal against international court rulings on Karaha Bodas dispute.

Ask senior officials at Australian mining company Rio Tinto, Canadian life insurers Manulife and probably any foreign bank that has ever chosen to invest in Indonesia about the pros and cons of doing business there. It is highly likely that they will offer some strong opinions about the subject: particularly the cons.

All types of foreign investors have encountered at one time or other difficulties with the legal system, or rather the enforceability of law in Indonesia. But as the Karaha Bodas Company (KBC) has discovered in the past three years, getting an Indonesian company to accept an international ruling - even when it has been deemed fair by courts in five different jurisdictions - has proved to be an impossible task.

KBC, which lists two US renewable energy developers Caithness Energy and FBL Energy as its majority owners, was formed in 1994 to develop and operate two geothermal power plants on Java. In November 1994, KBC entered into a joint operating contract (JOC) with Pertamina - Indonesia's state-owned oil and gas giant - and a 30-year energy sales contract (ESC) with Pertamina and PLN, the state electricity company.

Having already invested $100 million in the development, KBC was understandably aggrieved when in 1998 - under decree by former President Suharto - the government ordered the suspension of all geothermal projects in Indonesia. As KBC was no longer officially able to continue its business, the company sought a settlement to the issue.

In the JOC and ESC, Pertamina and KBC agreed that any disputes would be settled by way of international tribunal in Geneva, Switzerland under United Nations guidelines. It was Pertamina that requested Swiss arbitral tribunals, as this had been written into previous contractual agreements between Indonesian state-owned businesses (including PT Telekom, Pertamina and PLN) and foreign enterprises.

With neither party able to reach an amicable out-of-court settlement, the case went to the Swiss Tribunal in September 1999. In December the following year, the Swiss court ruled in favor of KBC and ordered Pertamina and PLN to pay KBC approximately $261 million for proven and uncontested expenditures, lost profits and the legal costs incurred.

Pertamina appealed against the decision on the grounds that $261 million was a marked up number, arguing that the eight exploration wells would have cost a total of $32 million. The company has lost two subsequent appeals against the Swiss ruling; the second of which last August was a final ruling and can not be appealed a third time.

Unwilling to accept that decision, Pertamina has since refused to pay KBC any damages, and has instead sought to annul the Swiss ruling in other countries. Sadly for Pertamina, the company has found that courts in the US, Canada, Hong Kong and Singapore have judged the Swiss tribunal's ruling to be fair, so in a final desperate act, the company is seeking annulment from the one jurisdiction it can be guaranteed a favorable ruling. No prizes for guessing which country that is!

Even if, as expected, Pertamina does get the decision it wants from the Indonesian courts, the proceedings in other countries mean that KBC should have no problem getting its hands on the $261 million. Pertamina has had its assets frozen by a number of US banks in which it has accounts, and the Hong Kong Court has issued interim Orders that gives KBC a beneficial interest in Pertamina-held shares in three HK companies: Tugu Insurance, Pertamina Energy Trading and Korea Indonesia Petroleum. The Canadian and Singapore courts have made similar rulings to freeze any assets Pertamina has in those jurisdictions.

It will not surprise you to know that Pertamina is contesting against these rulings as well, but once these have been appealed and most likely rejected, KBC will finally get what it was awarded two years ago and the case can finally close.

Nonetheless, the whole episode has not exactly been an exercise in good PR for Indonesia, and for a country that is desperate for foreign investment it can ill afford any more negative publicity. But the fact that it is a state-owned company involved in such a dispute, and one that has full government support, is not exactly going to make foreign investors comfortable about doing business in the country.

Christopher Dugan is a partner with the law firm Jones, Day, Reavis and Pogue and has been acting as the chief litigator for KBC in the dispute. He is damning of the stance Pertamina has taken and has strong views about what the dispute says about doing business with Indonesian companies.

"Pertamina is now claiming that that only the Indonesian courts have the proper to authority to rule on the case, even though it agreed to settling it in Switzerland from the outset," says Dugan. "This is preposterous but even if it does get the ruling it wants, this will not have any effect to the proceedings in the US or other courts. The facts are that Pertamina - a company with $14 billion revenues - cannot hope to do business in the long-run and escape the rulings of international courts.

"The consequences of this are obvious," he adds. "This kind of case can only cause a degradation in Indonesia's image and will jeopardize future foreign investment. When the country's leading company refuses to accept an arbitrary ruling, which has been deemed fair in several countries, it shows that some companies do not feel bound by contracts and the fact the government allows them to get away with this does nothing to help Indonesia's reputation and further erodes the confidence of foreign investors."

According to Dugan, the KBC-Pertamina dispute has no legal president. "This is a unique case in my opinion," he argues. I cannot think of another example where such a large company has forced a creditor to chase it down in six jurisdictions. Normally in these situations, companies will either pay or post a bond, which is basically a promise that they will pay if they lose an appeal. Pertamina has simply refused to do this. It just will not accept that is has lost."

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