Karaha Bodas Company - v - Pertamina and PLN

In the mid-1990s, Caithness Energy (a US party), Tomen (Japan) and an Indonesian partner agreed to develop specific geothermal sites in Indonesia to produce up to 400 mw of electricity, through a joint venture company that they set up, Karaha Bodas Company ("KBC").

KBC operated as a contractor to Pertamina, the state owned Indonesian oil company with authority over geothermal energy. KBC agreed on Pertamina's behalf to sell and deliver the electricity produced to PLN, the state-owned Indonesian electricity supplier. PLN agreed to buy the electricity on a take-or-pay basis. The price was fixed in US dollars. PLN had entered into similar arrangements with all 27 independent power producers.

In 1997, soon after the contracts were agreed, Indonesia was hit by the Asian currency crisis. As a result of this, since the contracts set prices in dollars, payments in rupiah would have been up to six times higher than had been contemplated when the contracts were signed. PLN could no longer afford to pay the contracted price.

The government issued three presidential decrees, first postponing the KBC contract, reinstating it, and then in January 1998 suspending it again.

In April 1998, KBC commenced arbitration proceedings against Pertamina and PLN in Geneva pursuant to the arbitration clauses in its contract, claiming some US$96 million for investment already made and US$512 for loss of future profits. In 2000, the arbitrators ruled that Pertamina and PLN were in breach of contract and awarded KBC in excess of US$260 million. KBC's shareholders had the benefit of political risks insurance to whom the insurers subsequently paid US$75 million.

In situations of dramatic price fluctuation, it is sometimes possible to renegotiate the contracts and thereby prevent the matter from being litigated. If this had been achieved, this would doubtless have substantially reduced the losses payable by the insurers. The terms of the relevant insurance contract have not been reported, and so the extent to which the insured was required under its policy to mitigate its losses is unclear. How far the duty to mitigate extends also acquires great importance in this context.

The matter did not rest there. Insurers did have the benefit, of course, of a first claim on any recoveries made by KBC pursuant to the arbitration award. KBC initially sought to enforce in Indonesia, but unsuccessfully: the Jakarta Central Court apparently on grounds of "international justice" annulled the award in 2002. It is understood that KBC is now pursuing collection from Pertamina's assets in Singapore, Hong Kong, Canada and the United States.

In the context of political risks insurance, subrogation is an important weapon in insurers' armoury for mitigating losses. Consequently, part of the risk profile in any particular situation depends on the jurisdictions in which the counterparty has assets. Fortunately, many jurisdictions are signatories to the New York Convention on the Recognition and Enforcement of Arbitral Awards - Indonesia included - although not all are as ready to give effect to their obligations under the Convention, notwithstanding the political and economic importance of doing so. Having an arbitral award annulled in one jurisdiction may arguably prejudice its enforceability in other jurisdictions. It might have been better to commence enforcement proceedings in a more arbitration-friendly centre than Indonesia.