Israel's Supreme Court strikes down Natural Gas Deal on Stability Clause - A Summary of the Court's Judgment

In an earth-shaking decision this Sunday, Israel’s Supreme Court struck down the government’s natural gas plan finding the stability clause unconstitutional. In an 4-1 judgment, the court found that the clause included in an agreement signed last December with Israeli and US gas companies unduly restricted future governments’ freedom to regulate the gas market and hence is undemocratic. The stability clause was supposed to restrict the government and the Knesset (the Parliament) from changing the plan for a period of ten years and serve as protection from regulatory changes in taxation, antitrust limitations and export quotas. Since the clause was a prerequisite for the plan, the entire plan was rejected and hence the development of the huge Leviathan gas field found in the exclusive economic zone of Israel in the Mediterranean is again put on hold for an undefined period. The government was given a period of one year during which it could fix any problematic aspects of the deal. At the end of that period of time, if a deal is not worked out, the plan will be cancelled.
Deputy Supreme Court president Elyakim Rubinstein wrote: "The stability clause in this chapter of the plan, in which the government undertakes for a decade to not only not legislate but to also fight any legislation against the plan’s provisions, was determined without authority – and as such is rejected. It was determined in contrast to the general principle of administrative law regarding the prohibition of shackling the authority’s ability to govern. The government does not have the power to decide not to decide and not to act."
Rubinstein added that this was especially the case when the government seeks to limit the discretion of the next government, "whose composition and ideology will be different than this one’s." Rubinstein also stated that the stability clause substantially binds the Knesset’s ability to use its discretion.

What follows below is a summary that I have prepared of the decision, focusing on the stability clause, which is the element of the deal that was struck down and which caused the whole deal to be suspended.

What Exactly is "The Stability Clause"?

The “clause” is actually not formally part of a written contract, but a chapter in the government resolution that created the “Gas Plan” and that was reached after negotiations with the gas companies and hence resolved the dispute with them. It was agreed by all parties to the litigation that the status of the stabilization clause was not one of contract, but of a “governmental promise” (a concept of Israeli administrative law, something like “an administrative entitlement”) which usually is considered to bind the government, except for in special circumstances when it is justified to depart from it.

In this chapter (chapter 10) titled “A Stable Regulatory Environment”, the government undertakes to refrain from changing, for a period of 10 years, its policy and regulation in relation to the gas market within three areas: Taxation – as set out in the existing law and in the Plan; Export – As determined by Government Decision 442; Antitrust – as determined in the plan. The government also undertakes to oppose any private bill tabled in the parliament aimed at changing anything in the above fields. If such private bill should pass nevertheless, the government undertakes to initiate a bill that will reinstate the previous situation. The government also undertakes to carefully examine any change in the regulation of the gas market and to aspire to design a policy that corresponds with accepted standards in OECD countries. The chapter includes milestones – in 2017 and 2020 – that allows the government to re-evaluate its commitment if the development of the Leviathan gas field should not progress in accordance with the gas companies’ commitments.

Justice Rubinstein's Opinion - Why the Clause is Illegal and Undemocratic

Justice Rubinstein, Deputy President of the Court, who wrote the main opinion, reviewed the international literature on stabilization clauses and explained the background to their use. In particular he quotes from John Ruggie’s report for the IFC and the UN on “Stabilization Projects and Human Rights” as well as from an article by Waelde and Ndi published in 31 Texas Int’l L.J. He says that these clauses can be divided into two main categories: Freezing clauses and Economic Balancing clauses. The former, in turn, divides into two kinds: Complete Freezing clauses, where the contract with the private investor is completely isolated and protected from any changes in regulation, and Partial Freezing clauses, where the protection only relates to a certain field/s, typically taxation.

The Economic Balancing clauses are different in that they do not freeze changes in regulation, but rather put a price tag on them. In some cases the government undertakes to provide full compensation for such changes, and in others there is negotiation between the parties on how to rebalance the arrangement.

He quotes several examples of freezing clauses, while stressing the fact that the states involved are all developing countries. He then quotes from an article by Cameron who writes:
"In most countries (including the UK, for example), the executive cannot give binding commitments about taxes or rates of taxation in the future. Indeed, it can be assumed that in every country the sovereign retains the power – in spite of any laws or contracts to the contrary – to enact laws that legally will ‘trump’ previous laws (and contracts) and that attempts to ‘freeze’ a petroleum contract will be unenforceable"
Peter D. Cameron, Stabilization in Investment Contracts and Changes of Rules in Host Countries: Tools for Oil and Gas Investors, at p. 30 (Association of International Petroleum Negotiators, 2006).

Justice Rubinstein notes that it is therefore not surprising that OECD countries do not include stabilization clauses in contracts with energy companies (Ruggie, p. 19) and that these are used mostly by states with a weak judicial system, in terms of independence, corruption, due process etc, what Coale calls “quasi-states” (Margarita T.B Coale, Stabilization Clauses in International Petroleum Transactions 30 Denv. J. Int'l L. & Pol'y 217, 221-222 (2001-2002))

He also quotes from the following article:

"One of the curiosities of stabilization clauses is that no developed country will offer them to investors… Developing countries tend to negotiate individual contract terms, whereas in the OECD the content of contracts or licenses is scarcely affected by any negotiations between IGCs [International Gas Companies – E.R] and host governments, since the terms on offer are largely standardized" (Mansour & Nakhle, at p. 13).

Justice Rubinstein then goes on to describe and analyze the rule in Israeli administrative law that provides that the government may not preclude itself and future governments from using its discretion in matters within its authority. He notes that while governmental promises (and contracts) are binding on the government, in exceptional cases they may depart from them where changed circumstances justify it. However, he stresses, they are not allowed to refrain from using their discretion in order to decide if such circumstances exist, which he says the government has committed itself to doing in this case. There are five conditions that must be met for a governmental promise to be binding and one of them is that the organ that gave it was authorized to do so. Here, he concludes, the government was not and therefore it is not binding.

Rubinstein, J. bases his conclusion also on the reasoning that the Gas Plan is a comprehensive primary arrangement that ought to be regulated by primary legislation passed by the Knesset (the parliament) and not by an administrative act of the executive branch. Only there can a transparent, democratic procedure occur where all the principles of the natural gas market regulatory scheme will be discussed and determined by the elected representatives of the people. [Since these aspects are less of interest to this group, I will not elaborate on his detailed discussion on this matter.]

If the Clause Goes - The Entire Plan Goes!

Since the government lawyers (and, in fact, Netanyahu himself, who appeared before the Supreme Court, making it the first time in Israeli history) stressed that the stabilization clause is a condition of the entire Gas Plan, and since the Court decided that the clause wasn’t valid, the Court reached the conclusion that the whole plan had to be struck down. It did so, even though all of the other challenges that the petitioners had raised against the plan had been dismissed.  The Court postponed the effect of its decision by 12 months, in order to give the government the time to reach an alternative arrangement that will be part of a legislative scheme approved by the Knesset.

Justice Joubran's Opinion

Justice Salim Joubran concurred. Of his detailed opinion it is worth mentioning one point. Justice Joubran makes the point that from a practical point of view the “Plan” is seen as a compromise agreement between the government and the gas companies and was also referred to as such in a recent OECD report. In view of that, he says, one cannot expect foreign companies to understand the intricacies of Israeli administrative law, which allow in certain circumstances to depart from “governmental promises”. For them, says Joubran, this is an agreement and they therefore will expect the government to fully live up to its promise not to change the regulation under any circumstances. Therefore, this amounts to an almost absolute negation of the government’s obligation to use its governmental discretion, which is invalid under the law.

The Dissent - J. Solberg: The Clause is Legal!

Only one judge, Justice Noam Solberg dissented and was of the opinion that the stabilization clause is valid. He stressed the fact that the clause did not restrict the Knesset’s right to legislate, and that it therefore remains free to initiate changes to the regulation if it thinks that is required. The government’s undertaking to actively oppose such attempts does not mean that the Knesset won’t succeed if the necessary majority is found. Judge Solberg also notes that government obligations to initiate certain laws in the parliament are not uncommon; such obligations are undertaken, for instance, pursuant to international agreements concluded by the government (and which do not require parliamentary approval, like in the UK) or pursuant to election promises by political parties, and there is nothing illegitimate in that. He does not see any distinction between the obligation to legislate a certain law and the obligation to actively oppose the legislation of a certain law. Both of them relate to how to use its governmental discretion in relation to legislation. While he agrees that an absolute denial of government discretion is unlawful, he is of the opinion that this is not the case here, since the government always has the right to depart from a government promise when special circumstances justify it. In such case, the government will have to compensate the investors, and hence the clause in question is not much different from an economic balancing clause, which Justice Rubinstein appeared as willing to accept. Judge Solberg acknowledges that such duty of compensation may create a “chilling effect” (a topic that is often discussed in connection with Bilateral Investment Treaties), but he doesn’t see this as negating the government’s discretion. The extent of the effect (as a function of the amount of compensation) depends on the nature of the change and of the expenses it causes to the investors, and sometimes this will be found to be a so-called “efficient breach” where the gains from the change in regulation exceeds the costs of compensation.

As for the claim that this is a primary arrangement that should have been made by the parliament, Solberg notes that the government has in fact been authorized by the parliament to take decisions in each of the three fields dealt with by the Plan (competition, export and taxation) and that being an extremely complex economic arrangement it is more suitable for professional civil servants to negotiate and design, than for the parliament. He therefore proposes to dismiss the petitions against the Gas Plan, while noting the Court’s interpretation of the stabilization clause as subject to the government’s right to depart from it in special circumstances where this is justified by public policy.

The Outcome - Counting Votes

Two more judges (Fogelman and Hayut) concurred with Justice Rubinstein, and hence the Plan was found invalid because of the stabilization clause (4 to 1). However, the majority (3 against 2) of the judges rejected Justice Rubinstein’s opinion that a new Plan must be made by parliamentary legislation.

In view of this decision, the government is now examining its options in trying to salvage the Gas Plan. One, perhaps unrealistic, option is if the gas companies wave their demand for a stabilization clause. Another option is to replace the partial “freezing clause” with an “economic balancing clause”. However, in such case, it is likely that the gas companies (and even more so the banks that are asked to provide the financing for the $5-8 billion required to develop the Leviathan gas field) will ask for a government financial guarantee. Such demand raises both political and financial problems that are beyond the scope of this already too long account.