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THE FLETCHER SCHOOL OF LAW AND DIPLOMACY

When Power Failures Undermine International Business Negotiations: A

Negotiation Analysis of the Dabhol Power Project

A MALD Thesis

Presented to

Jeswald Salacuse

By PRIYA GHANDIKOTA

April/2002

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Abstract: The purpose of this paper is to investigate the institutional factors that lead to the collapse of

international business deals. To develop a working framework from which to discuss this problem, the Enron-promoted Dabhol Power project in Maharashtra, India will be discussed as a case study. Traditional business strategy fails to internalize the social, cultural, political and ideological dimensions of complex business transactions. A preliminary examination of the Dabhol case reveals that many of the problems that led to the inability and unwillingness of the parties involved to implement a business agreement can be explained by negotiation theory. Negotiation theory accounts for the personality of the players, asymmetrical power relations, the lack of cultural know-how, and other complex issues in the pre-negotiation, negotiation and post-negotiation phases that lend insight into why international business agreements may fail. This paper begins with a translation of the history of the Dabhol project, continues with the application of negotiation theory to analyze the problems that arose and concludes with a model that attempts to correlate factors explained by negotiation theory that collectively produce a successful international business negotiation strategy.

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When Power Failures Undermine International Business Negotiations: A Negotiation Analysis of the Dabhol Power

Project

TABLE OF CONTENTS

PART I. INTRODUCTION........................................................................................................................................................ 6

PART II. THE HISTORY OF THE DABHOL POWER PROJECT ............................................................................ 9 A. INDIAS ENERGY SECTOR.............................................................................................................................................9

An Energy Sector in Need of Investment........................................................................................................................... 9 The Move Towards Reform...............................................................................................................................................11

B. THE SIGNED MOU WITH ENRON...............................................................................................................................12 C. EVENTS LEADING UP TO THE SIGNED PPA .........................................................................................................13

Public Protest......................................................................................................................................................................13 The World Banks Initial Conclusions............................................................................................................................13 The Initial Findings of the CEA .......................................................................................................................................14 The World Bank Report .....................................................................................................................................................16

C. NEGOTIATION OF THE PPA.........................................................................................................................................19 Sovereign Guarantees........................................................................................................................................................20

D. CANCELLATION OF THE PPA ....................................................................................................................................20 The Results of the 1995 Maharashtra State Elections..................................................................................................20 The Report of the Cabinet Sub-Committee to Review the Dabhol Power Project...................................................21 Termination of the PPA .....................................................................................................................................................22 Arbitration............................................................................................................................................................................22 A Review Panel is Struck ...................................................................................................................................................24

D. RE-NEGOTIATION OF THE PPA .................................................................................................................................24 E. NON-PAYMENTS AND ESCALATING HOSTILITIES ..........................................................................................25

Invoking the Sovereign Guarantee...................................................................................................................................26 The Godbole Review Panel..........................................................................................................................................27 Pre-Termination Notice.....................................................................................................................................................30 Subsequent Rounds of Arbitration .............................................................................................................................31 Enrons Exit Strategy.........................................................................................................................................................32 Final Termination Notice.................................................................................................................................................33 The Singapore Meeting......................................................................................................................................................34 The Downfall of Enron.......................................................................................................................................................35

PART III. APPLYING NEGOTIATION THEORY TO EXPLAIN THE FAILURE OF THE DABHOL DEAL................................................................................................................................

A. UNDERSTANDING BATNA AND BATRNA..............................................................................................................38 The Indian Teams BATNA ...............................................................................................................................................38 Enrons BATNA...................................................................................................................................................................40 The Indian Teams BATrNA..............................................................................................................................................40 Enrons BATrNA .................................................................................................................................................................42

B. TIME DEFICIENCIES .......................................................................................................................................................44 Speed.....................................................................................................................................................................................44 When the Time is `Ripe.....................................................................................................................................................48

C. RESOURCING THE NEGOTIATIONS.........................................................................................................................48 Institutional Endowments..................................................................................................................................................49

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Corruption............................................................................................................................................................................49 Technical Endowments......................................................................................................................................................51 Inflationary and Deflationary Expectations...................................................................................................................52

D. ASYMMETERICAL POWER RELATIONS................................................................................................................54 Terms of the agreement......................................................................................................................................................54

E. TRUST AS A STABILIZING FORCE IN NEGOTIATIONS ....................................................................................56 F. INCORPORATING STAKEHOLDERS.........................................................................................................................58

Local Community................................................................................................................................................................59 The World Bank...................................................................................................................................................................62 The Bureaucracy.................................................................................................................................................................62 Indian Financial Institutions.............................................................................................................................................63 The Non-Resident Indian Community.............................................................................................................................64 When Stakeholder Interests Hold the Negotiation Process Hostage.........................................................................65

G. MORAL BASED POSITIONING VS. INTEREST-BASED POSITIONING........................................................67 The GOMs Changing Interests .......................................................................................................................................67 Enrons Interests.................................................................................................................................................................68 Surmounting hostilities - Blaming the other Leads to Moral Positioning...........................................................70 When Inflexibility of the Agreement Contributes to Inflexible Positioning ..............................................................73 Personality of the Players.................................................................................................................................................75 The Hand of the White House...........................................................................................................................................79

H. NEGOTIATING WITH CULTURAL BLINDERS......................................................................................................81 Theory...................................................................................................................................................................................82 Cultural Limitations in the Indian Teams Negotiating Strategy...............................................................................82 Cultural Limitations in Enrons Negotiating Strategy .................................................................................................84

I. ORGANIZATIONAL CONSTRAINTS AND INSTITUTIONAL MEMORY AS DEBILITATING FACTORS......................................................................................................................................................................................................85

Organizational Precedents................................................................................................................................................86 Institutional Memory As a Constraint in the Decision-making Process...................................................................86

J. THE IMPORTANCE OF EFFECTIVE AND BROAD-BASED COMMUNICATION.........................................87 Theory...................................................................................................................................................................................87 The Breakdown of Effective Communication between the Negotiating Parties.......................................................87 The Breakdown of Effective Communication with Stakeholders................................................................................88

K. SUMMARY..........................................................................................................................................................................90 PART IV - CONCLUSION ......................................................................................................................................................92

A. VERNONS OBSOLESCING BARGAINING FRAMEWORK...................................................................................................92 B. AN INTEGRATIVE APPROACH TO ANALYZING BUSINESS TRANSACTIONS...................................................................93 C. CONCLUDING REMARKS......................................................................................................................................................96

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TABLE OF FIGURES

FIGURE 1 - REGIONAL POWER CAPACITY.............................................................................10 FIGURE 2 - BREAKDOWN OF RESPONSIBILITIES OF JV PARTNERS (1993) ....................20 FIGURE 3 - CAPITAL COST, ENERGY COST AND SIZE OF "FAST TRACK" PROJECTS IN

INDIA ....................................................................................................................................22 FIGURE 4 - INDIA'S BATNAS .........................................................................................................38 FIGURE 5 - RAYMOND VERNON'S OBSOLESCING BARGAIN MODEL................................................93 FIGURE 6 - BALANCING CONSTRAINTS TO NEGOTIATE A SUCCESSFUL BUSINESS DEAL ...............96

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When Power Failures Undermine International Business Negotiations: A Negotiation Analysis of the Dabhol Power

Project

PART I. INTRODUCTION

"The end crowns all, and that old common arbitrator, time, will one day end- William Shakespeare, Troilus & C, Act IV, Sc.V

The purpose of this paper is to investigate the institutional factors that lead to the collapse

of international business deals. To develop a working framework from which to discuss this

problem, the Dabhol Power project will be discussed as a case study. The Dabhol Power

Company (DPC) was established as a joint venture between the Enron Corporation, General

Electric and the Bechtel Corporation. A Power Purchasing Agreement (PPA) was signed

between the DPC and the state Government of Maharashtra in India to generate a 2,015 MW

base load power project at Dabhol in the Ratnagiri district, approximately 300 km south of

Indias commercial and financial center of Mumbai. Divided into two phases, the project

succeeded a re-negotiation of its terms, two changes in government, and twenty-four lawsuits.

Nevertheless, the DPC ultimately collapsed, with the future of its assets still uncertain.

The Dabhol Power project was chosen as a case study because of its significance to the

development of Indias foreign investment policy and the unprecedented size and scope of the

project. Indeed, this project is the largest single foreign investment project in Indias history.

Furthermore, it is a significant case study because the project was first regarded as a boon to an

ailing energy sector faced with a myriad of demand-driven and supply driven problems. The

company was created to serve a sector in India that is highly politicized, fraught with corruption

and a sector that was expected to provide maximum linkages to other sectors of an economy that

was poised for growth. The state electricity boards have suffered from consistent losses and

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approximately a quarter of the power stations in India are over twenty-five years old and the

inefficient maintenance of these stations has led to the breakdown of equipment and the shutting

down of plants.1 Power shortages have had serious repercussions for Indias program of

development since industry and transport account for seventy per cent of Indias power

consumption.2 Finally, not only was the Dabhol deal expected to heal an ailing energy sector, but

it was also touted as a symbol of economic reform, as it rode on the coattails of the aggressive

liberalization reforms pursued by the Government of India (GOI) after 1991.

From an international business perspective, the Dabhol Power project is an exemplary

case of how and why international business transactions fail in large part due to a lack of

strategic negotiation acumen. While the Enron-promoted project in Maharashtra is unique with

respect to the size and scope of the project, it is not unique with respect to the institutional

factors that led to its demise. Many of the problems that explain why the agreement was never

fully implemented are problems that have surfaced in numerous other cases where international

business deals have been negotiated, both in India and in other countries. For example, the

problems inherent in the Dabhol deal have manifested themselves in other deals such as the

Government of Indias failed negotiations with Bechtel Enterprises from 1963-1965 and the

controversial energy agreement now the subject of dispute between US-based AES and the state

government of Orissa in India.3

Traditional business strategy, which is dominated by an applied microeconomic or

macroeconomic approach that originates at the firm level or at the country level, provides only a

1 Abhay Mehta, Power Play: A Study of the Enron Project (Abhay Mehta. Power Play: A study of the Enron Project (Hyderbad: Orient Longman Ltd, 1999), p.12. 2 Harvard Business School, Enron Development Corporation: The Dhabol Power Project in Maharashtra, India (A) , Case No. 9-797-086 (Cambridge, Massachusetts: Harvard Business School Publications, 1997), pg. 6 3 Ashok Kapoor provides an excellent analysis of the events leading to the failed mfp signed between the GOI and Bechtel Corporation. See Ashok Kapoor, International Business Negotiations: A study in India (New York: New York University Press, 1970).

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limited explanation of the structures and events that lead to the failures of international business

deals. Specifically, this discipline fails to internalize the social, cultural, political and ideological

dimensions of complex business transactions. A preliminary examination of the Dabhol case

reveals that many of the problems that led to the inability and unwillingness of the parties

involved to implement a business agreement can be explained by negotiation theory. Negotiation

theory accounts for the personality of the players, asymmetrical power relations, the lack of

cultural know-how, and other complex issues in the pre-negotiation, negotiation and post-

negotiation phases that lend insight into why international business agreements may fail.

This paper begins with the history of the Dabhol project, continues with the application

of negotiation theory to analyze the problems that arose and concludes with a model that

attempts to correlate the factors that collectively produce a successful international business

negotiation strategy. This model attempts to bridge the gap between negotiation analysis and

traditional business strategy, where the latter is defined by a distributive bargaining framework,

which features the competitive behavior and interests of the firm and the industry or country as

key players.

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PART II. THE HISTORY OF THE DABHOL POWER PROJECT `Enron came, they saw, and they conquered

Maharashtra Chief Minister Manohar Joshi, Speech to the Maharashtra State Assembly A. INDIAS ENERGY SECTOR

The Dabhol Power Company (DPC)4 is a fascinating case study primarily because the

project was created to serve a sector in India that is highly politicized, fraught with corruption

and a sector that was expected to provide maximum linkages to other sectors of an economy that

was poised for growth.

An Energy Sector in Need of Investment The DPC was first regarded as a boon to an ailing energy sector faced with a myriad of

demand-driven and supply driven problems. At the time that an investigation was underway to

study the viability of the project, per capita consumption of power in India was only 190KwH

compared with 600 KwH for Malaysia, 3,000 KwH for Taiwan, and 10,000 KwH for the United

States. Indias relative low consumption rate can be explained not by the fact that demand for

power was low but by the fact that there was an insufficient supply of power generated. In 1991-

1992, demand for power throughout the country exceeded supply by 22.5 billion KwHs and grew

to 23.8 billion KwHs the year after.5 Power demand in India today outpaces supply by 11.1 per

cent during peak periods.6 These shortages have had serious repercussions for Indias program of

development since industry and transport account for 70% of Indias power consumption.7

4 In popular press, the Dabhol debacle is also referred to as the Enron debacle; therefore, throughout this paper, references will sometimes interchangeably be made to the Dabhol Power Company and Enron. 5 Harvard Business School, Case (A) , 6.

6 P.N.V Nair. Power Sector Needs Urgent Reforms, November 26, 2001 (accessed December 5, 2001); available from www.projectsmonitor.com. 7 Harvard Business School, Case (A) , 6.

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Figure 1 - REGIONAL POWER CAPACITY

Region Central Government Capacity

Total Regional Capacity

Northern States 9287 MW 23820 mw Western States 5512 MW 24301 MW Southern States 4640 MW 19459 MW Eastern States 2730 MW 12302 MW N. Eastern States 356 mw 1282 MW

(Source: Harvard Business School, Enron Development Corporation: The Dabhol Power Project in Maharashtra, India (A), Exhibit 2)

The problem of energy shortfalls in India can be explained not only by the phenomenon

of demand outpacing supply but also by the inefficient management of existing power plants.

Specifically, India suffers from one of the highest transmission losses in the world and has one of

the worlds lowest utilization of installed capacity.8 According to one estimate, by 2007, the

additional installed generating capacity required will be 85,000 MW accounting for a GDP

growth rate of six per cent per year and 100,000 MW if the growth rate is eight per cent per year.

At a relatively low fixed capital charge of US$1 million per MW, this additional capacity would

require an investment of $85 to $100 billion US.9 Peaked demand is not met primarily because

power stations in India run on coal and coal is often not delivered on time because of a failure to

pay or due to the unavailability of transport. The State Electricity Boards (SEBs) themselves lack

the ability to pay their principal supplier, the National Thermal Power Corporation (NTPC),

which prevents the NTPC from paying Coal India (CIL) and other suppliers of fuel. In 1987-

1988, the State Electricity Boards had operated consistently at a loss except for the State of

Andhra Pradesh and Orissa in 1990-91, Maharashtra in 1986-87 and 1987 88 and Kerala in

1985-6. The total outstanding debt of all the SEBs to various suppliers equaled Rs18, 500 crore

8 Mehta,, p. 9. 9Kirit Parikh, The Enron Story and its Lessons, The Journal of International Trade & Economic Development 6, no. 2 (1997): 210.

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at the end of October 1998.10 The problem of unprofitable SEBs is compounded by the fact that

approximately a quarter of the power stations in India are over twenty-five years old and the

inefficient maintenance of these stations has led to the breakdown of equipment and the shutting

down of plants.11

Official sources estimate that SEBs currently experience an average transmission and

distribution (T &D) loss of 22 per cent. Unofficial reports estimate this figure to be 48 per cent.12

The primary reason for these losses can be explained by politically driven subsidies offered to

wealthy farmers and domestic consumers.13 Concessional power amounts to as much as 46 per

cent in some states.14 According to The Economist, the SEBs have also become job creation

centers for friends and relatives of politicians.15 As one author states, the Delhi Electricity

Supply Undertaking is one of the most corrupt and bankrupt organizations in the country.16 In

addition to politically driven subsidies, T & D losses can also be explained by transmission theft.

In New Delhi, transmission theft accounts for nearly fifty-four per cent of all T & D losses.17

The Move Towards Reform

During the Fifth Plan of the National Planning Commission, electricity was included in

the minimum needs program.18 In the hopes of addressing the major structural deficiencies

confronting the energy sector in India, the Electricity Supply Act (ESA) of 1948 was amended in

1991. The revised Act adopted a cost-plus approach and assured a return of equity of 16 per

10 Mehta, 12. 11 Ibid. 12Yamini Narayanan. Privatization of the Electric Utility Industry in India: A Case Study (Ph.D diss, University Of Oklahoma, 1998), p. 35. 13 Ibid., p. 21. 14Ibid., p. 35. 15Ibid., p. 36. 16 Mehta, 9. 17 Ibid., 8-9 18Narayanan, 19.

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cent on investment in this sector.19 In May and June 1992, the Government of India established a

team to visit the United States in pursuit of attracting foreign direct investment for Indias energy

sector. The Houston-based energy company, Enron Corporation, responded favorably to the

Government of Indias proposed reforms and expressed an interest in setting up a power station

in India based on the import of liquefied natural gas (LNG).

B. THE SIGNED MoU WITH ENRON

Almost immediately after the Indian delegations promotional trip, representatives from

Enron and General Electric arrived in India to survey sites for a potential project. Three days

following their survey, on June 20, 1992, they signed a Memorandum of Understanding (MoU)

with the Maharashtra State Electricity Board (MSEB) to build the Dabhol Power Project. The

operating entity of the project would be the Dabhol Power Company (DPC), a joint venture

between the Enron Corporation, General Electric and the Bechtel Corporation. The MoU,

although not a legal document, stipulated that the company would establish a 2,015 MW base

load power project at Dabhol in the Ratnagiri district, approximately 300 km south of Indias

commercial and financial center of Mumbai. DPC would lease the project site from the

Maharashtra Industrial Development Corporation.20. The project was initially established to

generate 2,550 megawatts (MW) at a cost of $3.1 billion. Acting upon the recommendations of

the Foreign Investment Promotion Board, the proposed project was later scaled down to 1,920

MW, at a capital expenditure priced at $2.65 billion dollars and most importantly, the project

was split into two phases. Phase I would run on imported distillate oil until LNG supply

19 Mehta, 24. 20 Siva Y Sankar. Dabhol Power Co to export fruits, flowers; available from www.rediff.com/money/2000oct/06dabhol.htm).

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contracts were secured and a LNG re-gassification plant and storage and harbor facilities were

developed as part of Phase II.21

C. EVENTS LEADING UP TO THE SIGNED PPA Public Protest

The statement by Maharashtra Chief Minister Joshi that Enron came, they saw, and they

conquered,22 while extreme and lined with political pretension, reflected the attitude of many

opposed to the Enron deal. In light of this fact, it is remarkable that the Dabhol Power project

steam-rolled ahead, at the pace that it did, in an environment where public and political

opposition were fierce and where there was a low estimation of the benefits of the project and its

viability amongst various local stakeholders. On July 7, 1994, Ramdas Nayak, a member of the

BJP, a Hindu nationalist party, filed a High Court case against the Indian Government and the

DPC on the grounds that the project was tainted by a lack of transparency and competitive

bidding. Similarly, local residents and activists launched appeals to the Government of

Maharashtra (GOM) to halt the project on the shared belief that environmental standards had

been violated. Between 1992-1993, through the forum of public hearings and written

correspondence, many local residents expressed the fear that the construction of a mega-power

project in Dabhol would threaten their economic livelihood.

The World Banks Initial Conclusions

After the Memorandum of Agreement (MoU) was signed amidst public protest, the GOM

requested the World Bank to review the project. On July 8, 1992, the World Bank concluded,

this large project which is nearly 20 per cent of its (MSEBs) installed capacity is likely to have

21Harvard Business School, Case (A) , p. 3 22 The GOMs translation of Chief Ministers Statement in the Maharashtra State Assembly; available from http://altindia.net/enron/Home_files/doc/gomSuit/Cmstate.html

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an adverse financial impact.23 The World Bank cautioned the Maharashtra State Secretary for

Energy and Environment that the MoU was one-sided in favor of Enron and encouraged the

government to verify Enrons experience as an electricity generating company before

proceeding with the project.24

The Initial Findings of the CEA

The amended Electricity Supply Act of 1948 specified that companies submitting

proposals of projects exceeding a capital expenditure of twenty five crores were obligated to

submit a scheme to the Central Electricity Authority (CEA) which included revenue details,

financing agreements, costs, and supply and generation estimates. The CEA was therefore

approached in early August 1992 by the Indian Secretary of Power to examine the technical and

economic viability of the tariff, the cost considerations, and the welfare impact of the Dabhol

project on Maharashtra. Similar to the World Banks analysis, the CEA concluded that the

Dabhol project was not economically or technically viable. Specifically, the CEA estimated the

cost of the plant to be Rs.1.81 crore per MW and Rs. 1.91 crore per MW, according to an

estimation of December 1996 and December 1997 completed costs, and not Rs. 4.49 crore per

MW as approximated by Enron.25 This significantly lower deduction in costs led the CEA to

conclude that the DPC tariff structure needed to be significantly reduced to a more realistic

estimate of total real costs. The CEA further argued that that the MoU did not produce pertinent

details of the project including the total costs of the project, when the contract would begin, or

when the electricity would be made available. There was a minimum level of cooperation

exercised between Enron and the CEA as Enron insisted on providing lump sum estimates of

23 Mehta, 28. 24 Human Rights Watch, The Enron Corporation: Corporate Complicity in Human Rights Violations, 1999 (accessed December 5, 2001); available from http://www.hrw.org/reports/19999/enron/enron2-1.htm. 25 Mehta, 52.

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its costs. On November 10, 1993 in a letter addressed to respond to the CEAs request for a

segmented breakdown of project costs, DPC officials replied, It is important to notethat

capital costs are irrelevant to CEA26. DPC further claimed, (y)our request for more detailed

project costs of equipment/system/works other than those provided in the capital cost summary

cannot be supported and is not deemed necessary.27

Concerns Raised by Enrons Legal Team

As the CEA continued to express its reservations about the project and as the agency

began to re-consider the total foreign exchange outgo upon request by the Indian High Powered

Board, Enrons London-based legal team at Linklaters and Paines submitted a report to the

Government of India outlining what it deemed to be legal and regulatory impediments to foreign

investment in India. The report, entitled, Problems Concerning the Application of the Indian

Electricity Acts, was submitted on September 4, 1992. One of the main concerns of the report

was that the tariff regulations raised by the Government of India were found to be incompatible

with the financial structure of a power station project in light of the assumed load factors, the

admissibility of foreign exchange variations, the permitted return on equity, and the five year

term of the tariff as stipulated in the pricing provisions of the PPA.28 The legal team raised the

additional point that the indiscrete power afforded to the MSEB and the CEA to regulate DPC

activities constituted a conflict of interest, as the CEA was the administrative agency selected to

exercise juridical functions over any disputes arising between the DPC and the MSEB. In

addition, Enron expressed concern about the remedies available for breach of a statutory duty.29

Finally, the Enron legal team raised objection to the fact that under the Electricity Acts, the DPC

26 Mehta, 61. 27 Ibid. 28 Ibid., 32. 29 Ibid.

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would be obligated to furnish to the CEAaccounts, statistics, returns of other information

relating to the generation, supply and use of electricity, adding to the DPCs existing

obligations under the Companies Act.30

The World Bank Report

On March 12, 1993 the Finance Ministry formally approached the World Bank to finance

the project. When submitting his report on April 30, 1993, World Bank India Country Director,

Heinz Vergin, wrote to M.S. Ahluwalia, Secretary to the Department of Economic Affairs in the

Indian Ministry of Finance, Our analysis based on the parameters provided to us indicated that

the LNG-based project as presently formulated is not economically viable, and thus could not be

financed by the Bank.31 The World Bank submitted its full report on April 30, 1993 to the

Finance Ministry, which then forwarded the report to the Secretary of Power. In the report, the

World Bank expressed concerns about the fact that a LNG plant was being promoted instead of a

combined cycle production plant with coal, since LNG generation at a variable cost of about 150

k/WH is much higher than coal-based production of 30 k/WH.32 Coal production would also

allow the electricity boards to achieve significant cost advantages by relying on domestic

equipment and domestic suppliers, thereby decreasing foreign exchange outgo.33

The World Bank further argued that the willingness of industrial consumers to pay for

electricity had been estimated at Rs. 2.2 kWH in the western region of Maharashtra, and 2.4

kWH in Bombay, which were amounts substantially lower than the Rs. 4.6 kWH stipulated in the

DPC proposal. According to the Bank, consumers had expressed a willingness to pay higher

30 Ibid., 32-33. 31 Letter of April 30, 1993 signed by Heinz Vergin, India Country Director at the World Bank, addressed to Secretary of the Department of Economic Affairs, Indian Ministry of Finance; available from http://www.altindia.net/enron/Home_files/Wbnote.htm. 32 The World Bank, India: Dabhol Power Project, April 30, 1993; available from http://www.altindia.net/enron/Home_files/Wbnote.htm, line item 5. 33 Mehta, 40.

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tariffs only for guaranteed and/or additional supply during peak periods.34 The World Bank

further critiqued the viability of the project on the grounds that the implementation of the

project would place a significant long-term claim on Indias foreign exchange resources with

the capacity payments (starting) at about US $175 million in 1996 and escalating at 5% per

annum, reaching $US 400 million in 2015.35

Responding to allegations that the MSEB overestimated growth of demand for energy,

the MSEB maintained that there existed pending applications from certain industries for

additional supply amounting to 4,100 MW, thereby increasing the peak load by 2100 MW by

1997.36 Addressing this point, the World Bank argued that there was no substantive evidence

determining that there were pending applications and even if the peak load was expected to

increase, the LNG-based power plant was not the least cost option to meet surplus demand.37

The World Bank concluded its report by advocating that investment needed to be targeted

towards alternative energy projects (e.g. coal production).38 Enron management did not perceive

the report to be entirely damning or immovable. In a letter addressed to the head of the MSEB,

Joseph Sutton, Vice-chairman and head of the Enron Development Corporations Asia

Operations, confidently wrote, I recently met with the World Bank and have been following the

articles in the India papers. I feel that the World Bank opinion can be changed. We will engage a

PR firm during the next trip and hopefully manage the media from here on.We need now to

put the PPA behind us.39

34 The World Bank, India: Dabhol Power Project, line item 13. 35 The World Bank, India: Dabhol Power Project, line item 7. 36 Mehta, 40-1. 37 Ibid., 41. 38 The World Bank, India: Dabhol Power Project, line item 11. 39 Mehta, 199.

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Taking the lead on this confident note and in the first of many strategic miscalculations to

follow, the Chief Minister of Maharashtra Sharad Pawar decided to overlook the

recommendations of the World Bank and the CEA and in an August 1993 meeting with the High

Powered Board, announced that the issues raised by the CEA were all issues that could be

examined in a final review and were minor issues to be clarified.40 The project was

subsequently approved by the various departments of the state government, the State Cabinet

Ministry of Power and Finance, the Central Government and the Foreign Investment Promotion

Board which was comprised of a high level committee of secretaries of the Central

Government.41

On November 26, 1993, the CEA in principle granted provisional clearance. This

clearance, however, was not a final determination and was made with significant reservations. A

study of the correspondence between the GOM and the CEA, and Enron executives and the

GOM during this period suggest that the clearance was executed under pressure by Enron and

the GOM so that Enron could finalize its financing for the project. In a letter to Chief Minister

Pawar, Rebecca Mark wrote:

The remaining concern seems to reside with Mr. Beg, Member Planning for Thermal Projects. He continues to hold up the project approval based upon the question of demand for power in Maharashtra .we have a project under the governments fast track program, approved by FIPB, but the CEA refuses to grant a clearance.It is critical that we get the Power Purchase Agreement approved and signed now and that we start Phase I financing immediately. Because of GOM delays in approval and the associated negative press of the last few weeks, the project is in danger. We are working on financing arrangements prior to project approval but the banks in India and externally are losing their enthusiasm based on lack of progress.We need to make immediate progress.42

The CEA clearance was conditional on a readjustment of the price of electricity, the policy of

importing liquefied natural gas and on DPCs ability to obtain other government permits from

40 Ibid., 53. 41 Ibid., 142.

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the Ministry of Environment and Forests and the Port Trust for construction of their harbor and

port facilities.43

C. NEGOTIATION OF THE PPA

On December 8, 1993, a week after the CEAs preliminary clearance was issued, the

Purchasing Power Agreement (PPA) of the first phase of the project was signed. DPC would

build, own and operate a plant of approximately 2,000-2,400 MW capacity, which would be run

on liquefied natural gas (LNG). The LNG plant would maintain an average plant load factor of

ninety per cent.44 The Dabhol project would cost Rs. 4.36 crores/megawatt (MW) and the DPC

would sell to the MSEB at a rate of Rs. 2.65/kWh in 1997 and the rate would increase after that

date. The MSEB and GOM were responsible for building the transmission lines from the power

station to its power grid. By the time DPC was ready for commercial production, the MSEB

would still be obligated to make the capacity payments irrespective of whether the State followed

through with its infrastructure commitments. The MSEB was required to purchase power from

the DPC under a two-part tariff. The first part of the tariff was determined by established base

load and peaking capacities. The second part of the tariff was determined by the actual output of

power. The PPA further stipulated that after twenty years from the commencement of

commercial production, the MSEB would have the option to extend the contract for five or ten

years.45

Loan commitments amounted to $643 million and equity contributions amounted to $279

million for Phase I of the project. The major foreign lenders included the Bank of America, the

42 Ibid., 204.

43 Human Rights Watch, The Enron Corporation. 44 Average plant load factor is an indicator of operational efficiency as it measures the actual energy produced by the power plant as a percentage of the maximum capacity of the plant. Break down of Average Plant Load Factor (PLF): 92 per cent during the eight peak non-monsoon months and 86 per cent during the off-peak months.

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Overseas Private Investment Corporation, the Export-Import Bank of the United States (EXIM

Bank) and various Eurobank guarantors. The Indian creditors included the Industrial

Development Bank of India (IDBI), the State Bank of India, the ICIC, the Industrial Finance

Corporation of India and Canara Bank, with the IDBI assuming maximum exposure of risk.

Figure 2 - BREAKDOWN OF RESPONSIBILITIES OF JV PARTNERS (1993)

(Source: HBS Case A, Exhibit 1) Sovereign Guarantees

On February 10, 1994 the State of Maharashtra issued a sovereign guarantee, assuming

liability for all of MSEBs dues to the DPC under the PPA. On June 24, 1994, the State Support

Agreement was signed between the GOM and the DPC. On September 16, 1994, the Union

Ministry of Finance, on behalf of the Government of India, signed a counter guarantee.

D. CANCELLATION OF THE PPA The Results of the 1995 Maharashtra State Elections

In an interesting sequence of events, the February 1995 State elections in Maharashtra

brought the project to an abrupt halt. The Hindu nationalist party, the Bharatiya Janata Party

(BJP), won the Maharashtra elections to form a coalition government with the more conservative

and fundamentalist religious party, the Shiv Sena (SS). The BJP-SS alliance officially took over

the political reigns of power in April 1995. The new nationalist, swadeshi-oriented46

government produced a different trajectory in the states vision of development and foreign

45 Harvard Business School, Enron Development Corporation: The Dabhol Power Project in Maharashtra, India (B) Case No. 9-797-085 (Cambridge, Massachusetts, Harvard Business School, 1997), page 11.

Company Enron Power Corporation

Bechtel Enterprises Incorporated

General Electric Company

Equity $223 million $28 million $28 million Responsibilities Construction management,

operations and maintenance, fuel management

Construction and Contractor

Construction

21

investment. Bal Thackeray, leader of the Shiv Sena party, often preached on the evils of foreign

investment and rendered popular the slogan, Justice to All, Appeasement to None. With

respect to the Dabhol project, the two most immediate mandates of this government were to

replace the chairman of the MSEB and to establish a cabinet sub-committee to review the

project. This committee was established on May 3, 1995 and was headed by Deputy Chief

Minister, Gopinath Munde.

The Report of the Cabinet Sub-Committee to Review the Dabhol Power Project

The Report of the Maharashtra Cabinet Sub-Committee to Review the Dabhol Power

Project recommended the termination of the project based on the conclusion that the cost of the

project was inflated at least by twenty-five per cent47 and that there was a lack of competitive

bidding and transparency that resulted in a one-sided agreement which favored Enron and its

partners. The committees report specifically cited regulations that had been relaxed to expedite

the project. The Cabinet Sub-Committee, also known as the Munde Committee, further argued

that a proper environmental impact assessment of the project was not executed. Finally, the

Committee determined that the Dabhol project was more expensive than other fast-track

projects (see Figure 3 below).

46 Swadeshi translates to home rule and was one of the nationalist slogans employed during Indias Independence movement. 47 This estimate is based on a study of the US based Advanced Light Water Rector Program (ALWR) which cites other projects such as the Jerapadu and Godavari gas-based projects in the range of 3.52-3.60 crore per MW.

22

Figure 3 - CAPITAL COST, ENERGY COST AND SIZE OF "FAST TRACK" PROJECTS IN INDIA48

Project Size (MW) Capital Cost (Rs.Crore per MW)

Cost of Energy (Rs. Per KW)

NTPC-Gandhar 648 3.53 -------- GVK-Jegurupadu 216 3.52 2.21 Spectrum-Godavari 208 3.60 1.87 Torrent-Gandhar 654 4.27 2.17 Enron-Dabhol 695 4.49 2.40 Congentrix-Mangalore* 1,000 5.08 2.59 AES-Ib Valley* 420 4.82 2.39 Ashok Leyland-Vizag* 1,000 5.81 ---- CMS-Neyveli 250 4.50 3.10 NTPC-Kayamkulam* ----- 3.20 2.61 NTPC-Faridabad ----- 3.00 2.12

(Source: HBS Case Study-B; referencing the Ministry of Power, Dabhol Power Company) *Coal Powered Projects

Termination of the PPA

The report of the Munde Committee symbolized the first of many events that effectively

rendered the agreement void. Based on the Committees findings, on July 8, 1995, the new Chief

Minster, Manohar Joshi, announced to the Maharashtra State Assembly that the Government of

Maharashtra had decided to cancel the second phase of the project and halt directives associated

with the first phase of the project. Chief Minister Joshi in his admonishment of the project made

what is now an often-cited declaration (from) the speed with which this process was completed,

one can say that `Enron came, they saw, and they conquered.49 Joshi continued to state that the

decision to cancel the agreement was, not against the United States; but against the Dabhol

project. The deal is against the interest of Maharashtra. Accepting this deal would indicate an

absolute lack of self respect and would amount to betraying the trust of the people50

Arbitration The PPA included an arbitration clause that committed the MSEB and DPC to dispute

resolution should the two parties not be able to resolve the conflict through non-legal means.

48 These projects were under negotiation at the time that the case study was written (December 1996). 49 The GOMs translation of Chief Ministers Statement in the Maharashtra State Assembly

23

Arbitration would be conducted in London and would be presided over by a panel of

independent experts in accordance with the United Nations Commission on International Trade

Law (UNCITRAL) rules of arbitration and the 1958 New York Convention. The DPC chose to

invoke this clause by initiating arbitration in London against the MSEB and the GOM to claim

damages well over $300 million (Rs. 1,000 crore).51 Throughout the arbitration proceedings,

however, Enron repeatedly and publicly expressed its willingness to renegotiate the terms of the

agreement.52

In response to the DPC initiating arbitration, on August 3, 1995, the Government of

Maharashtra filed suit against the DPC in the Bombay High Court seeking cancellation of the

PPA on grounds of fraud, corruption and a lack of competitive bidding. The Government of

Maharashtra argued in court that the PPA was null and void on the basis that it violated several

statutory provisions, including sections 18, 29, 30, and 43A of the Electricity Supply Act, and

that the PPA suffered from the vice of misrepresentation by Enron and was conceived in

fraud.53 On August 19, 1994, the Bombay High Court ruled that an open invitation for

competitive tenders should have occurred to ensure the transparency of the deal.54

Enrons commitment to the project was demonstrated by its efforts to resuscitate

negotiations by engaging in significant diplomatic maneuvering after the cancellation of the

project. Joseph Sutton, Scott Bayman from General Electric, Ashok Mehta , Vice-President of

DPC, and Sanjay Bhatnagar from the Enron Development Corporation made a trip to New Delhi

during the second week of April 1995 to meet with the Union Minister for Power, N.K.P Salve,

50 Harvard Business School, Case B 4. 51 Jeswald W. Salacuse, Renegotiating International Project Agreements, Fordham International Law Journal 24, no. 4. (April 2001): 1352. 52 Chris Ayres. Enron to pull out of Indian project, The Times (London), November 6, 2001 (accessed December, 2001); available from Lexis -Nexis Academic Universe. 53 Mehta, 147. 54 Ibid., 141.

24

Finance Minister, Manmohan Singh, and the General Secretary of the BJP, Pramod Mahajan.55.

The DPC team received the assurances it needed from the Center to forge ahead. Specifically,

Salve was forthright in his declaration that the Center was committed to continuing the project

and that the State of Maharashtra should honor the pact because a renouncement of its

contractual obligations would have adverse ramifications for the entire nation.56 On November 7,

1995, Rebecca Mark met with Bal Thackeray, founder and leader of the Shiv Sena party in

Maharashtra. Thackeray was an important political figure with whom to reconcile differences, as

he remains an influential nationalist, with little sympathy for foreign investors and he has

immense political connections throughout Maharashtra. Despite having missed a scheduled

meeting with Manohar Joshi, Mark was later able to secure a commitment from the Chief

Minster that the GOM would explore the possibility of recommencing negotiations.

A Review Panel is Struck

On November 8, 1995, the GOM commissioned a Review Panel, comprising of

government officials, academics and industry experts.57 Based on its negotiations with the Enron

team and principal critics of the project, the panel submitted a proposal to the GOM on how to

restructure the Dabhol deal with recommendations to restructure the electricity tariff, capital

costs, terms of payment and delineation of environmental responsibilities.58

D. RE-NEGOTIATION OF THE PPA

The renegotiated agreement transformed the Dabhol deal into the single largest foreign

direct investment project in Indias history. The recommendations put forward by the Review

55 Mehta, 143-144. 56 Ibid., 144. 57 Salacuse, Renegotiating International Project Agreements, 1353. 58 Ibid., 1353.

25

Panel lay the foundation for the amendments made to the PPA. Specifically, the total capital cost

of the plant was reduced by $330 million to US$2.51 billion.59 The plant was reconfigured to be

a multi-fuel generating plant, which would run on naphtha during Phase I. This adjustment had

the benefit of reducing Indias dependence on imported fuel and lowering the capital costs of the

project. Additional capacity was negotiated from 695 MW in Phase I to 740 MW and in Phase II,

from 2,015 MW to 2,184 MW. The committee also fixed a price of 5.9375 cents/kWhr for Phase

I and 5.906 cents/kWhr for both phases.60 The load factor remained set at eight-six per cent.61

Responding to criticism about the environmental impact of the project on local horticulture and

fishing, the renegotiating committee arrived at an agreement whereby there would be regular

monitoring of marine life and whereby the DPC would plant one hundred and fifty hectares of

mango and cashew trees in the area.62 One of the most important features of the newly structured

deal was the allocation of thirty per cent equity in the project to the MSEB, and a reallocation of

Enrons equity holding from eighty to fifty per cent.

On May 27, 1996, the Union Cabinet issued an extended counter guarantee. In August

1996, each party withdrew their respective suits in their courts to sign the renegotiated PPA. By

May 1999, final construction of the project had completed and the project received financing for

its second phase. By March 1999, Phase I was well underway while Phase II was expected to

commence in 2001.

E. NON-PAYMENTS AND ESCALATING HOSTILITIES

In October 1999, a new government came into power in the State of Maharashtra. This

government, led by the Democratic Front (DF), was fragile and politically dwarfed by its many

59 Parikh, 216. 60 This amount translates to Rs. 1.90k/Whr for Phase I and Rs.1.89/kWhr for both phases. See Parikh, 217. 61 Ibid., 217.

26

alliances and coalitions. Inheriting an incredible deficit of 9,848 crores from Chief Minister

Joshis government, the newly elected Democratic Front government in Maharashtra, led by

Vilasrao Deshmukh, discovered that it could no longer sustain payments to the DPC. In February

2001, Chief Minister Deshmukh remarked (l)et us face it. We cannot afford the power given to

us by the DPC. The MSEB is in no position to pay the monthly power bills Dabhol sends to us.

We have asked the Centre to buy all the power generated by Enron, from both phases of the

project and distribute it through the NTPC (the National Thermal Power Corporation) grid. If we

want power for the state, we will buy it from NTPC.63 Deshmukh also declared, we have given

all the necessary powers to the MSEB Chairman to take any action, including disconnection of

power supply lines, against defaulters. We need full police force for this. We are prepared to do

this.64 Even the Indian Finance minister admitted that the cost of power supplied by the DPC

was too high and the government would have to see if the state can use all the power generated

and that if the excess power can be wheeled out to needy states.65

Invoking the Sovereign Guarantee

During the first week of February 2001, under pressure from its lenders, the DPC

responded to the MSEBs refusal to pay its dues by invoking the GOIs counter-guarantee.66 The

GOI argued that it would not pay the estimated amount of Rs. 1.02 crore (15 million pounds) on

the grounds that Enron engaged in certain technical violations.67 Specifically, the GOI

62 Ibid., 220. 63 Raghunatha, TN. Empowered to overpower problems, The Pioneer, Feb. 18, 2001 (accessed December 5, 2001); available from www.dailypioneer.com. 64 Siva Y. Sankar. Maharashtra move may help solve Enron tangle, February 7, 2001 (accessed December 5, 2001); available from www.rediff.com/money/2001/feb/07enron.htm. 65 Binoy Sharma. Centre to send sole representative, April 25, 2001 (accessed December 5, 2001), available from www.dailypioneer.com. 66 Sujata Anandan, Enron willing to amend Power Purchase Agreement, The Hindustan Times, February 9, 2001 (accessed December 5, 2001); available from www.hindustantimes.com. 67 Khozem Merchant, Enron Dispute heading for Court, April 9, 2001 (accessed December 5, 2001; available from http://globalarchive.ft.com.

27

concurred with the MSEBs allegation that the DPC had fallen short in its guaranteed supply of

power and therefore was subject to the RS. 401 crore non-performance penalty as stipulated by

the PPA.68 On September 11, 2001, the DPC invoked a letter of credit (LoC) from the Canara

Bank accusing MSEB for non-payment of dues. The MSEB countered this action by restraining

the DPC from encashing the LoC by obtaining an injunction from the Mumbai High Court,

which was later upheld by the Supreme Court on September 21.69 That same week, the DPC

invoked its second federal counter-guarantee.70

The Godbole Review Panel

To respond to tensions mounting between the DPC and the MSEB, a review panel was

established by the GOM. The panel was headed by Dr. Madhav Godbole, former finance

secretary, and was comprised of energy experts.71 In April 2001, the Godbole Panel submitted its

review report of the Dabhol project. In this report, the panel recommended de-linking the LNG

terminal from the project, restructuring the loan repayment clause in the PPA, and removing the

dollar-rupee denomination of payments. Probably one of the most significant statements made by

the Godbole Review Panel Report was its resignation of the fact that though development of

DPC has been fraught with infirmities, its existence cannot be wished away and it now stands as

a near completed project on Indian soil.72 The Panel, therefore, arrived at the conclusion that a

restructuring of the Dabhol project was needed.

68 Centres firm no to DPC, The Pioneer, August 18, 2001 (accessed December 5, 2001); available from www.dailypioneer.com. 69 SC decides to continue interim order, The Statesman (India), November 3, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe. 70 Khozem Merchant, India to hold inquiry into Enron Affair. 71 Energy experts on the committee included N. N. Lele and R N Pachouri, long associated with Tata Electricity and Kirit Parikh, of the Indira Gandhi Institute of Development Research. 72 Godbole Panel Stresses on negotiation with DPC, The Pioneer, April 13 2001 (accessed December 5, 2001); available from www.dailypioneer.com

28

The Godbole Re-Negotiating Committee

Chief Minister Deshmukh ultimately resigned himself the fact we can not bring down

the cost of power (sold by the DPC) unless the PPA is re-opened. The issues like the rupee-dollar

parity which has contributed to the hike in the power rates will have to be considered while

undertaking re-negotiations.73 At the end of April 2001, his government, acting on the

recommendation of the Mumbai High Court to arrive at an amicable settlement, commissioned

the Godbole panel to form a committee to renegotiate terms of the PPA with Enron. Pressured

from the leftist groups in Deshmukhs coalition government, the committee was commissioned

to ultimately bring down the cost of power by restructuring the tariff rate, to explore the options

of attracting third party purchasers of the energy, and to ultimately soften what had become to be

perceived as a hardliner stance developed by Enron.

Recognizing that other state electricity boards could share in absorbing excess capacity

generated by the Dabhol plant during off-peak periods, the Godbole committee immediately

began to organize simultaneous meetings with the SEBs. Representatives of the state electricity

boards from Madhya Pradesh, Karnataka, Delhi and Punjab met the Madhav Godbole Committee

on July 26, 2001 to negotiate buying power from the DPC but their expectation of price and

supply was too low to ease the financial pressure of the Maharashtra government. With the

exception of the SEBs of Madhya Pradesh and Punjab, which were willing to pick up

approximately 200 MW as base load power, the other states were seeking a power arrangement

that would meet seasonal shortfalls of power.74

The efforts of the Godbole committee to arrive at a renegotiated settlement was severely

hampered by the various legal acrobating that was simultaneously taking place in London and in

73 Maharashtra softens stand ahead of London meet, The Pioneer, April 26, 2001.

29

Mumbai by the GOM, DPC and Indian creditors. Furthermore, three of the committee members

resigned from the committee in an act of protest directed towards the leadership of Dr. Madhav

Godbole and the political interference exercised by the Center. One of the members of the

committee who resigned, R.K. Pachauri, argued that Dr. Godboles suggestion of a judicial

enquiry into the DPCs activities, would have the unintended consequences of driving the Enron

team farther away from the negotiating table. In one interview, he stated (h)ow long do such

judicial enquiries in India normally take and how many have achieved anything tangible? Can

the government of Maharashtra renegotiate a deal with Enron if a judicial enquiry is in progress,

and would the public accept any such deal till the enquiry is over? And till it is over, the

Government of Maharashtra would continue to run up huge bills even as the State is unable to

absorb the power generated by Dabhol.75

On May 3, 2001, the efforts of the Godbole committee became further impeded when the

Enron team backed out of a meeting scheduled for May 5 with officials of the state government,

the MSEB and members of the Godbole committee to re-chart the renegotiation process.76 Even

when the energy company initially agreed to meet, it cautioned, the published terms of

reference of the Godbole report do not represent an acceptable basis for further

discussionsThis meeting should in no manner be construed as an open offer from DPC to

renegotiate the terms of the contract.77 The Dabhol team made clear that any specific proposals

brought forward for renegotiation should be premised on the principle of lifting the entire base

74 Julie Earle. Enron wants out of Indian Power Project in The Financial Times (London), July 27, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe. 75 R K Pachauri rejects Godboles suggestion to institute `Judicial Enquiry, available from http://www.teriin.org/news/may012.htm 76 Agenda for fresh talks with Enron chalked out, Business Line, May 5, 2001 (accessed March 31, 2002); available http://www.blonnet.com/businessline/2001/05/06/stories/14065607. 77 DPC agrees to meet govt panel as a `courtesy: Godbole terms of reference not acceptable, rediff.com, May 4, 2001 (accessed December 5, 2001); available from http://www.rediff.com/money/2001/may/04enron.htm

30

load power produced at the plant.78 They further reasoned that no exercise of re-negotiation

would be fruitful for them without a basic assurance of payment for the second phase of the

project, which was due to go online on June 7, 2001. Since the MSEB could not provide for

these assurances, the Enron team decided to issue its pre-termination notice.79

Before the pre-termination notice was actually issued, several attempts were made by the

Center to engage officials from the DPC, the MSEB and the GOM in a dialogue to resolve their

differences. On May 11, 2001, officials of Enron India and the Godbole committee met to

discuss the future of the Dabhol project with no headway, as the MSEB continued to reiterate its

stance that the DPC should adjust its dues owed by the MSEB for not achieving peak supply

levels.80

Pre-Termination Notice On April 26, in a decision of six to one, the Board of Directors of DPC had authorized

Neil McGregor, Managing Director, to issue a notice of intent to terminate the PPA at a future

date to be determined by the DPC management. The MSEB was not allowed to vote on the issue

because of its status as an interested party.81 On May 19, the DPC issued its pre-termination

notice. The pre-termination notice attributed the decision to terminate the project to the failure of

the MSEB to pay its dues amounting to two months of electricity payments, and to the MSEBs

unwillingness to increase the size of the letter of credit and provide escrow cover as provided for

in the PPA. According to clause 17.8 of the termination procedure outlined in the PPA,

following the giving of a preliminary termination notice, the parties shall consult for a period of six months (or such longer period as they may agree) as to what step shall be taken with a view to mitigating the consequences of the relevant event

78 Dabhol issues termination notice still open to `solutions minus Godbole report, Business Line, May 20, 2001 (accessed March 31, 2002); available from http://www.blonnet.com/businessline/2001/05/20/stories/14205601.htm 79 Dabhol issues termination notice. 80 Talks begin on Dabhol Issue, Business Line, May 12, 2001, (accessed March 31, 2001); available from http://www.blonnet.com/businessline/2001/05/12/stories/14125602.htm 81 DPC board authorises MD to issue PPA termination notice, Business Line, April 27, 2001, (accessed March 31, 2001); available from http://www.blonnet.com/businessline/2001/04/27/stories/142756dh.htm

31

having regard to all the circumstances..82

The DPCs pre-termination notice, therefore, would expire on Nov.19, 2001, after which the

DPC board would have to approach its lenders for approval to issue a final termination notice.

As the MSEB continued to rescind on its contractual payments and its unpaid bills escalated to

approximately $185 million, DPC officials decided to shut down the first phase of the project

(740 MW) in May 2001.

At the end of July, Enron CEO, Kenneth Lay, formally announced Enrons intention to

sell its equity stake, signifying a formal departure from the project. Lay reported We have made

it pretty clear to the government leadership we are now at a point where we would like to be

taken out and we think most of our partners do.83 Wade Cline further explained we are not in

the business of litigation but of selling energy worldwide. November 19 is our exit path and no

way are we going to take a merchant risk in the power purchase agreement. I surely have a

distressed asset but not a distressed PPA.84

Subsequent Rounds of Arbitration

The DPC resorted to arbitration against the State Government, again on the basis of a

breach of contract. The company had accused the Government of not honoring its guarantees and

supplemental support guarantees by refusing to pay the amount due for MSEBs December and

January bills. The GOM responded to the arbitration proceedings again by filing its own suit in

the Bombay High Court alleging that the DPC had misrepresented terms of the agreement by

inflating the operating characteristics and scope of the project.85 The GOM further supported the

82 Ibid. 83 Earle, Enron wants out of Indian Power Project. 84 Enrons exit countdown begins from November 19, The Pioneer, August 13, 2001 (accessed December 5, 2001); available from www.dailypioneer.com 85 MSEB forced to rescind PPA?, The Pioneer, August 6, 2001 (accessed December 5, 2001); available from www.dailypioneer.com.

32

MSEBs argument that the DPC was required to adjust payments due by the MSEB according to

a Rs.401 crore penalty for performance default, as stipulated in the PPA. Furthermore, on

September 19, 2001, Indian authorities announced that they were to launch a judicial

investigation into the origins and legality of the $2.8 billion company. Fearful that this initiative

was an attempt to stall arbitration proceedings in London, by declaring DPC activities illegal, the

commercial court in London passed an ex parte order in October 2001 against the State

government restraining it from taking any legal action against international arbitration initiated

by DPC.86

Enrons Exit Strategy

Wade Cline, of the DPC, articulated the desire that apart from deflating the sale price of

its assets from $3 billion to $1 billion, at the end of the day, they wanted to complete the project

before leaving Dabhol. Though we are looking at exit routes, DPC is ready to get the original

contractors and ensure completion of the project as the original designs and drawings of the plant

are not with the company, but with them.87

Once it was clear that the GOI would not purchase Enrons equity stake in the company,

on January 30 2002, the IDBI invited Expressions of Interest (EOI) for acquisition of eight-

five percent stake in DPC from domestic and international companies with a minimum net worth

of $200 million or its equivalent in Indian currency or from a consortium with a net worth of

$400 million having requisite experience in managing and operating power and LNG plants.88

Three bidders, Tata Power Company, BSES Ltd. and the Gas Authority of India submitted their

EOIs. For practical reasons, Enron preferred selling its assets to a local Indian buyer. Wade Cline

86 India: Arbitrators meet in Singapore on Dabhol, Business Line, November 23, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe. 87 Enrons exit countdown begins from November 19.

33

argued that if a local buyer bought the project, the rupee-dollar parity, that became an issue of

contention in negotiations between the GOM and the DPC, would disappear if an Indian

company bought the project. Cline further maintained that the project then also could be run on

a 30 per cent plant load factorbelieve me no foreign guys are going to do that.89

Final Termination Notice

On November 6, 2001 Enron officially announced that it would serve its final termination

notice to close the power project after November 19, when a six-month deadline for resolving the

payment dispute would end.90 Enron served a notice to transfer the 2,184MW asset to MSEB and

was willing to demand compensation based on independent valuation.91 Domestic lenders,

including the State Bank of India, ICIC Ltd., the Industrial Development Bank of India and IFCI

Ltd., filed a lawsuit in the Mumbai High Court. The creditors demanded the immediate re-

commencement of the plant to protect their investments.92 On November 9, 2001, the Mumbai

High Court ruled in favor of the Indian creditors and issued and issued a stay order against the

DPCs final notice of termination. This action prevented the DPC from issuing its final

termination notice until a hearing was called, which would not take place until December 3,

2001. The Court further ruled that the fourteen-day period beginning November 19, during

which the DPC could file the final termination notice as per the PPA, would not expire.93

88 Expression of Interest Invited for DPC Sale, IndiaInfo.com, January 30, 2002 (accessed March 31, 2002); available from http://finance.indiainfo.com/news/2002/01/30/30enron.html 89 Enrons exit countdown begins from November 19. 90 Enron India Units lenders issue court challenge to prevent project pullout, AFX EUROPE, November 8, 2001 (accessed December 5, 2001); available from http://globalarchive.ft.com 91 Sanjeev Srivastava, Enron set to leave India, BBC News.com, November 6, 2001 (accessed December 5, 2001); available from http://news.bbc.co/uk/hi/english/business/newsid_1641000/164100.stm 92 Enron delays closure notice for Indian plant after legal action, Agence France Presse, November 19, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe. 93 Indian Court Bars Enron From Serving Financial Termination Notice, Asia Pulse, Nov. 12, 2001 (source: http://globalarchive.ft.com)

34

The Singapore Meeting

Following the action of the Indian financial institutions of filing a suit against the DPC,

the DPC decided to `boycott` the November 10-12 meeting held in Singapore where the DPCs

institutional lenders, including Citibank, ABN Amro and Bank of America and the IBDI and the

State Bank of India, met in a final attempt to discuss the financial restructuring of the DPC. After

the DPC received personal assurances from the Center and the financial institutions that they

intended to present new proposals at this meeting with respect to a negotiated settlement to the

dispute, the DPC agreed to attend the meeting.94 At the meeting, the lenders were concerned

about facilitating the sale of the Dabhol assets with prospective buyers, including Tata Power

and BSES. The financial institutions also devised a proposal that was ultimately rejected by the

MSEB. The proposal called for the MSEB to off-take power from Phase I and relinquish to the

potential new buyer its exclusive distribution area where there are key industrial centers. The

MSEB rejected this proposal with the argument that if it forfeited these prized areas, then it

would not be able to absorb the power from DPCs first phase of 740 MW. The MSEB further

protested the fact that FIs did not call us to the Singapore meet and had no right to make such an

offer without consulting and taking MSEB into confidence.95 An official at the MSEB went on

to declare that (f)inally, if things get sorted out and DPC is taken over by another company, it is

MSEB which is going to be the largest consumer of the plant, and strangely despite having a 15

per cent stake in the company, it is not even involved in DPCs sale process.96

94 Singapore meet spills over; no proposals given, says DPC, in rediff.com, November 9, 2001 (accessed December 5, 2001); available from http://www.rediff.com/money/2001/nov/09enron1.htm 95 `FIs completely ignored us in DPCs proposed sale says MSEB, The Press Trust of India, November 23, 2001, available from Lexis -Nexis Academic Universe. 96 Ibid.

35

The Downfall of Enron One of the most interesting developments that emerged in this case, is the downfall of the

energy giant Enron. Enrons declaration of bankruptcy on December 2, 2001 signified the largest

filing of bankruptcy in US history. The question of finding a local buyer through the Singapore

negotiations assumed less importance with respect to time and investment as Enron became

embroiled in a series of US federal investigations on the transparency of its accounting practices

and dealings. It was revealed that Enron had been omitting from its balance sheet financial losses

incurred in relationships with private partnerships run by some of its own corporate officers. As

Enron shares plummeted from $82 in January 2001 to $11.82 on November 5, 200197, Kenneth

Lay announced to Enron shareholders that Enron would regain billions from, among its many

assets, sale of its broadband telecommunications and its assets in Dabhol.98

One analyst states the Dabhol investment played an insignificant or no role in the

collapse of Enron. Several analysts concur with this argument maintaining that the company

went down under the collective weight of its extraordinary corporate ambitions and the

cumulative effect of sharp practices. 99 On the other hand, some Wall Street analysts had been

complaining that Enrons complex web of businesses had contributed to lack of clarity in its

financial reporting. An analyst at Salomon Smith Barney argued that the lack of strategic focus

in acquisitions and operations contributed to Enrons undisclosed financial losses. Raymond

Niles specifically argues that among other unrelated projects, power plants in India are

unrelated, or only tangentially related, to their core merchant energy business.100 The Enron

97 Ayres, Enron to pull out of Indian project 98 Stacie Babula, Enron falls amid concern debt threatens Dynergy bid, Bloomberg News, November 20, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe. 99 The Enron Collapse and India, The Free Press Journal, January 23, 2002 (accessed March 12, 2002); available from www.samachar.com) 100 Simon London and Sheila McNulty. Enron flickers: Once a paragon of the new economy, the US energy group is under scrutiny for its opaque accounting and free-wheeling management, The Financial Times (London) October 29, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe.

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collapse, however, did play a significant role in the fate of the Dabhol project. Specifically,

under pressure to sell its assets quickly to raise much-needed cash, Enrons bargaining position

was significantly depressed vis--vis DPCs potential local Indian buyers and the GOM. Amidst

allegations that Enron was over-leveraged and under pressure to cut costs in various business

segments, Enron highlighted the Dabhol project as one of its most notably poor investments and

noted that it would accelerate the process of trying to dispose of these failed assets to raise cash

to pay its $12 billion debt. As Ronald Barone of UBS Warburg states Tata would be a faster

exit and resolve it once and for all. It is better to take a small loss and move along. Dabhol

periodically becomes a problem and an issue, and it depresses the stock.101 As a result of this

decline in Enrons bargaining position, subsequent negotiations of the sale of the Dabhol assets

involved a sale price that was substantially discounted.

101 TATA in talks to buy Enron power plant, The Financial Times (London), October 15, 2001 (accessed December 5, 2001); available from Lexis -Nexis Academic Universe.

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PART III. APPLYING NEGOTIATION THEORY TO EXPLAIN THE FAILURE OF THE DABHOL DEAL

In fact, the entire negotiation with Enron is an illustration of how not to negotiate, how not to take a weak position in negotiations and how not to leave the initiative to the other side Report of the Munde Committee (August 1995)

When discussing the importance of the pre-negotiation phase, Harold Saunders outlines

four steps necessary to produce a commitment to a negotiated settlement: that it no longer serves

either partys interest to pursue the present situation (i.e. conflict situation); that the alternatives

to a negotiated settlement (BATNA) are not better than a foreseeable settlement; that each side

makes its own estimates of whether the other side would accept a negotiated solution and is

willing to reach a compromise; and finally, that an equal power balance exists to permit a fair

settlement.102 This framework of analysis captures several of the reasons why the Dabhol deal

failed, for even though a settlement was ultimately reached in the form of a negotiated PPA and a

renegotiated PPA, the agreement was undermined in various stages because it served the

interests of the ruling government to contest the PPA, because `compromise became an ugly

word when the Dabhol project became politicized and when mistrust escalated on each side and

furthermore when compromises were made, the right kind of compromises were not made and

finally, because the PPA reflected an asymmetrical power balance as it was negotiated with a

supply-side bias.

Elements of Saunders framework and other frameworks that draw from negotiation

theory and the field of conflict resolution will be explored in this section, as they lend insight

into the failures of the Dabhol project in India, and ultimately why international business

transactions can fail.

102Harold H. Saunders, We Need a Larger Theory of Negotiation: The importance of Pre-negotiating Phases in Negotiation Theory and Practice, eds. William J. Breslin and Jeffrey Z. Rubin (Cambridge, Massachusetts: The Program on Negotiation at Harvard Law School, 1999), 65-68.

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A. UNDERSTANDING BATNA and BATrNA

In Getting to Yes: Negotiating Agreement Without Giving In, Roger Fisher and William

Ury, argue that the best way to estimate a negotiated agreement is to measure it against what

would be considered to be the parties best alternative to a negotiated agreement (BATNA).103 In

the Dabhol case, the concepts of BATNA and what I refer to as BATrNA (Best Alternative to a

Renegotiated Agreement) help explain how and why both parties were willing to enter into

negotiations to construct the power project in Dabhol and ultimately why the parties agreed to

renegotiate the PPA in an environment of escalating hostilities.

The Indian Teams BATNA The table below is a summary of Indias alternatives to a negotiated PPA with Enron and its

partners.

Figure 4 - India's BATNAs

Ranking Alternatives Best Alternative

Contract a domestic private investor to build, own and operate the energy plant

2nd Best Alternative

Domestic company becomes majority partner in power project

3rd Best Alternative

Tap into alternative forms of energy sourced domestically (e.g. coal production)

4th Best Alternative

Have another foreign investor build, own and operate the energy plant

The Best Alternative and 2nd Best Alternative in this case were untenable in the Indian

context as Supriya Roychowdhury states, the ...private corporate sector in India has in general

failed to demonstrate the characteristics of a vigorous entrepreneurial class, has grown based on

state support and speculative behavior in a range of activities relating to underutilization of

capacities making quick profits in a protected market, using its monolithic structure to preempt

103 Roger Fisher and William Ury. Getting to Yes: Negotiating Agreement Without Giving In, 2nd ed, ed. Bruce Patton (New York: Penguin Books, 1991), 97.

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competition and to perpetuate a market of shortages.104 A study done by Yamini Narayanan

reveals that on a cost basis alone, there were incentives to pursue Enron as the lead supplier

instead one of Indias leading national suppliers of energy, the National Thermal Power

Corporation (NTPC)105, as Enron had the capacity and resources to supply power at a cost 8.45

million dollars less than that of the NTPC.106 The reconstruction and revitalization of SEBs have

been ear-tagged as investment risks by the World Bank, which made it difficult for the state

governments to borrow for electricity generation and therefore placed a premium on the need for

foreign investment.107 The GOM and the MSEB quickly disqualified the third best alternative

noted above, as demonstrated by their disregard of recommendations to explore domestic sources

of energy production such as coal production. Consequently, the merits and downfalls of this

third best alternative did not influence or inform their decision to enter into negotiations with

Enron. Finally, Enron, when compared to other foreign energy companies, was poised to be the

lead contractor, as it possessed a portfolio o