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China Fertilizer Spat Underlines Sri Lanka’s Struggles With International Trade Deals

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China Fertilizer Spat Underlines Sri Lanka’s Struggles With International Trade Deals

Sri Lanka has a lot to learn about entering agreements with  international companies – and the repercussions of violating them.

China Fertilizer Spat Underlines Sri Lanka’s Struggles With International Trade Deals
Credit: Depositphotos

In September of last year, the Sri Lankan government banned a shipment of 20,000 tons of fertilizer, worth $6.9 million, from China’s Qingdao Seawin Biotech Group Co., alleging that there were harmful bacteria in the fertilizer. The ensuing controversy has created a lively debate among analysts.

After months of “lawfare” in Sri Lankan courts and never-ending missives between the Sri Lankan government and Qingdao Seawin Biotech, the People’s Bank of Sri Lanka paid $6.9 million to the China-based fertilizer company in early January as compensation. Earlier, the Colombo Commercial High Court had dissolved the enjoining order preventing payment on a Letter of Credit to Qingdao Seawin Biotech, as all parties had agreed to settle their dispute by shipping a new stock of standardized fertilizer – despite Sri Lanka having rejected two previous shipments.

The disagreement between institutions under the government and Qingdao Seawin Biotech not only created a rare diplomatic tussle between China and Sri Lanka, but very nearly saw Sri Lanka taken before international arbitration courts.

While arbitration is an important tool in solving international trade disputes, it is costly and powerful. International entities can exert their dominance over sovereign governments that are already reeling from underdeveloped legal infrastructure and capacity. Sri Lanka has been taken to arbitration courts in the past, and its performance there has been less than stellar.

These forays have shown that Sri Lanka has a lot to learn about entering international agreements and the repercussions of violating them for reasons of sheer expedience. Sri Lanka’s lack of capacity to go toe-to-toe with the international legal experts employed by multinational corporations was most recently shown in the X-Press Pearl disaster. More than half a year on, the country is still struggling to get adequate compensation for the damages done to its environment and the fisheries industry by the massive chemical spill that resulted from a fire onboard the ship.

This time, however, the risks are greater. International companies are already hesitant to work with Sri Lanka, given its serious forex crisis and drop in credit ratings. KLS Energy Lanka, a subsidiary of a Malaysian renewable energy producer, has an ongoing arbitration case against Sri Lanka; a much-publicized arbitration issue with a large Chinese company on top of that could have a tremendous adverse effect on Sri Lanka’s ability to trade with foreign entities.

While the need for Chinese assistance in tackling Sri Lanka’s economic crisis obviously played a role in the brokering of an agreement between the Sri Lankan government and the Chinese company, it also confirmed that it was Sri Lanka that violated the agreement with Qingdao Seawin Biotech. In essence, the agreement with Qingdao Seawin Biotech was another international agreement Sri Lanka entered into without proper consideration, and drafted without the inputs of those with international commercial law expertise or experience.

Sri Lankan politicians and policy wonks view this crisis through the usual prism of sovereignty and China’s ability to influence, if not shape, policy in Sri Lanka. Yet the two main reasons for the crisis are the country’s underdeveloped legal infrastructure and the lack of capacity of various government entities to negotiate or sign agreements with international companies. Given that the country had been dragged before international arbitration courts by international companies a number of times in the recent past, and the possibility that it will face similar quagmires and confrontations in future, Sri Lanka should get its act together when making agreements with multinational companies.

As mentioned, this is not the first time that Sri Lanka entered into an ill-advised agreement with an international company. The most famous of these cases was the hedging agreement with CITI Bank, Standard Chartered Bank, and Deutsche Bank in 2008, to purchase crude oil at a predetermined price following an increase in global prices. Sri Lanka’s state run Ceylon Petroleum Corporation (CPC) entered this novel and rather unprecedented transaction with no previous experience, on dubious instructions.

However, crude oil prices in the global market dropped drastically months after the agreement was reached and Sri Lanka decided to suspend all hedging-related payments, following the Supreme Court ruling that the deal was in violation of the Constitution.

Deutsche Bank AG promptly started arbitration proceedings under the terms of the Germany-Sri Lanka bilateral investment treaty (BIT). The Bank claimed that Sri Lanka’s actions deprived it of the economic value of the Hedging Agreement and that the withdrawal of payments constituted a breach of Article 4 (2) of the BIT, which prohibited expropriation of an investor’s property. The Bank’s position was that the intervention of the Supreme Court and the Central Bank “amounted to indirect expropriation of their rights under the Hedging Agreement.”

The analysis of the Tribunal on these issues is highly pertinent. Some of the defenses cited by the Sri Lankan state in the ICSID arbitration – i.e. lack of capacity, lack of authority, and supervening illegality – raised serious concerns amongst foreign investors, because these are conditions that affect any foreign investment. The hedging transactions had been discussed and approved at the Cabinet level, prior to them being entered into and duly approved by the CPC Board. Moreover, the actions of the Central Bank of Sri Lanka following default by the CPC raised serious concerns with regard to the regulator itself.

While the case was settled in 2016, it seems unlikely that Sri Lankan policymakers have learned their lesson. In 2018, KLS Energy Lanka, a subsidiary of Malaysian renewable energy producer Energy SdnBhd, filed an arbitration case against the Sri Lankan government under BIT Malaysia-Sri Lanka 1982. The arbitration was filed over the cancellation of a $150 million wind-solar hybrid power project by the Sri Lankan government. Board of Control for Cricket in Sri Lanka v WSG Nimbus Pte Ltd. was another instance in which muddled agreements landed Sri Lanka in trouble.

More recently, agreements between Sri Lanka and India to develop the Trincomalee Oil Tank Farm as a joint venture between CPC and Lanka IOC state that the two parties have to go before arbitration courts in Singapore to settle any possible dispute. According to the terms of previous MoUs between the Lanka IOC and Sri Lanka vis-à-vis the Tank Farm, any issue arising between the two parties would have been solved via Sri Lankan law.

Given that the agreements between the parties – a lease agreement, a modalities agreement, and an agreement on the Joint Venture Company, i.e. Trinco Petroleum Terminal Ltd – have remained secretive, with only the modalities agreement presented to Parliament, it is likely that, as critics claim, the agreement is disadvantageous to Sri Lanka. The Education Secretary of the Frontline Socialist Party, Pubudu Jayagoda, stated, “Our previous performances before arbitration courts have been less than stellar. Given this context, this seems to be another agreement that lands us in trouble at international arbitration courts.”

Sri Lanka has tended to enter into agreements with international companies that have proved to be far from perfect. Sri Lankan politicians and courts have then responded to the issues that arise from these agreements in an ad hoc manner.

In cases such as Light Weight Body Armour Ltd v Sri Lanka Army and Elgitread Lanka (Private) Limited v Bino Tyres (Private) Limited, Sri Lankan courts appeared to have taken the view that they should circumscribe their powers within the ambit of the Arbitration Act and that parties must be encouraged to resolve disputes through arbitration. However, with regard to the Qingdao Seawin Biotech case, the Commercial High Court of Colombo ordered the People’s Bank not to honor the Letter of Credit it had issued. Perhaps the similarity of the court action and the behavior of politicians in this case compared to the hedging deal nullification is what triggered the Chinese to take swift action.

As Sri Lanka increasingly looks to make agreements with foreign companies in several fields, the chances of the country getting entangled in commercial disputes will rise. It is the responsibility of the state to make agreements with foreign nations that are transparent and subject to public dialogue before they are signed, so that inputs from wider sources can help rectify any potential issues.