Home Commercial book How Kenya’s Auditor General Misinterpreted China’s Standard Gauge Railway Contracts

How Kenya’s Auditor General Misinterpreted China’s Standard Gauge Railway Contracts

0

In December 2018, a leaked letter from the Kenyan auditor general’s office sparked a rumor that Kenya had staked its bustling port of Mombasa as collateral for the Chinese-funded standard gauge railway. Our new research shows why the collateral rumor is false.

Former Auditor General Edward Ouko was completing the 2017/18 audit of the National Ports Authority. He warned that the assets of the port authority – of which the port of Mombasa is the most valuable – risked being taken over by China Eximbank if Kenya failed to repay the $3.6 billion in railway loans.

The profitable port of Mombasa is East Africa’s main gateway for international trade. Launched in 2017, the railway was intended to seamlessly connect the port to Kenya’s capital, Nairobi, and landlocked countries beyond.

The Kenyan fears mirrored another widely reported story earlier in 2018. In that story, China allegedly “seized” the port of Hambantota in Sri Lanka when the island nation struggled to repay Chinese loans. This allegation of “debt trap diplomacy” was later revealed to be a myth, but not before sparking fears about other major Chinese projects.

Both the Chinese and Kenyan governments have denied that the Mombasa port was a guarantee but have offered no explanation. Perplexed by the leaked letterour team of scholars and practitioners of international trade law and project finance spent months collecting primary documents and mapping the contractual structure of the project.

To our surprise, we found that the collateral rumor stemmed from a seemingly small but critical misreading by the Auditor General. The chief auditor wrongly characterized the port authority as the borrower, responsible for repaying China’s rail loans. He claimed that by waiving sovereign immunity, the Kenyan government had “expressly guaranteed” that the port authority’s assets could be used to repay the Chinese loan. The Auditor General was wrong on both charges.

For the Auditor General, and many others, the debate over the Mombasa Railway and Port has been complicated by technical terms and practices. These are commonly used in the law and business of international project finance, but are unfamiliar outside of this area.

Although some public awareness would have been necessary, publication of the contracts (which Kenya’s High Court ordered the government to do last week) could have prevented the Auditor General’s error and allowed a debate on the facts rather than rumours.

Map the project

The four main stakeholders in financing the standard gauge railway were the National Treasury of Kenya (the borrower), Kenya Railway Corporation (the project company), Kenya Ports Authority and China Eximbank (the lender) . The figure below illustrates complicated contractual and payment arrangements.

the complexity of contractual and payment terms. Author provided

Kenya’s Treasury explained the railway’s financing arrangements and credit enhancements in detail during a 2013 briefing to Kenya’s parliament. The government had arranged several credit enhancements to enhance the financial attractiveness of the expensive project, making it “bankable”.

Among these was a “take or pay” agreement signed between the national railway company and the port authority. Under this 15-year agreement, the port authority has committed to ship (or “take”) a minimum amount of goods on the new railway each year. If freight shipments fell below the agreed annual level, the Kenya Ports Authority would draw from its own revenue to cover (“pay”) the shortfall.

The port authority is therefore the main customer of the Standard Gauge Railway, and not its collateral. The Treasury has also promised that the Railway Development Levy, a 1.5% levy on imports from Kenya, will support the project.

Mistakes

One of our most important findings is that the government’s chief auditor erred in calling the Kenya Ports Authority a borrower. If the port authority was the borrower, that would mean that it had co-signed the Chinese loans and was also responsible for repayment. But the Port Authority is by no means a borrower.

Clause 17.5 of the Quadripartite Agreement quoted by the Auditor General in his report set out the relationship: “Each of the Borrowers, Kenya Rail Company and Kenya Port Authority agrees…”

Our legal expert immediately noted that these were three entities: the Treasury of Kenya (the borrower), the railway company and the port authority.

Map showing East Africa and the lines.
East African Standard Gauge Railway. China-Africa Research Initiative.

Yet this distinction was missed by the Auditor General, who wrongly paraphrased the clause by referring to two entities: “each of the borrowers, in this case Kenya Railways Corporation and Kenya Ports Authority…”

The Auditor General then pointed to clause 17.5 to say that the Port Authority was a borrower and therefore its assets were at risk. The auditor accused the Port Authority of not disclosing it during the audit. The Auditor General was operating on faulty assumptions that influenced his opinion of the Port Authority’s responsibilities.

What does waiver of sovereign immunity mean?

The Treasury, the Kenya Ports Authority and the Kenya Railways Corporation have all signed “sovereign immunity waivers”. Indeed, all three were parties to various contracts as part of the package. Under international law, sovereign states and the entities they control enjoy sovereign immunity. This means that they are generally immune from legal proceedings and cannot be compelled to appear before a foreign court or an arbitration body, nor to enforce a judgment rendered outside their borders. Yet few international banks will offer a loan if there is no possibility of arbitration in the event of a dispute and no legal way to recover their money in the event of borrower default.

A published cache of loan contracts signed by Cameroon with banks and export credit agencies in Austria, India, Germany, Spain, Turkey and the United Kingdom shows that all demanded these clauses. As one American lawyer noted,

to omit a sovereign immunity waiver from an international commercial loan agreement would be professional misconduct.

However, there is quite a big gap between a general waiver of sovereign immunity and the specification of a particular asset as a post as collateral.

Our findings clarify similar rumors that borrowing governments pledged strategic assets like land or ports in exchange for Chinese funding. These are Zambia (Kenneth Kaunda airport), Uganda (Entebbe airport) and Montenegro (Bar port).

Debt-trap diplomacy’s fear of borrowers’ strategic assets being directly (and deliberately) threatened by Chinese banks continues to fail the test of evidence.The conversation

Deborah Brautigam, Bernard L Schwartz Professor of International Political Economy, Johns Hopkins University

This article is republished from The conversation under Creative Commons license. Read the original article.