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Russia ordered to pay USD 50 billion for actions designed to bankrupt oil producer

29 September 2014

In the case of Yukos Universal Ltd (Isle of Man) v The Russian Federation, UNCITRAL, PCA Case No AA 227, Hulley Enterprises Ltd (Cyprus) v The Russian Federation, UNCITRAL, PCA Case No AA 226, Veteran Petroleum Ltd (Cyprus) v The Russian Federation, UNCITRAL, PCA Case No AA 228, 18 July 2014, it was ruled that Russia breached its international obligations under the Energy Charter Treaty (the ECT) by taking actions designed to bankrupt Yukos, formerly Russia's largest oil company. Russia was ordered to pay damages to former Yukos shareholders in excess of USD 50 billion, plus USD 60 million in legal fees. A panel of arbitrators, under the auspices of the Permanent Court of Arbitration in The Hague, rendered the Yukos award, by far the largest ever publicly known arbitration award. The arbitrations began in 2005.
Russia sought to rely on the ECT's carve-out for "taxation measures" (Article 21(1)), maintaining that this provision exempted Russia's conduct from ECT protection. Moreover, Russia argued that Yukos' "unclean hands" barred its ECT claims. The Tribunal rejected both objections. On the tax carve-out, the Tribunal concluded that States cannot avoid their investment treaty obligations simply by labelling a measure as a "tax". Article 21(1) only applies to bona fide tax measures which are designed to raise revenue for the State, and not actions taken "to achieve an entirely unrelated purpose … such as the destruction of a company". As for the "unclean hands" argument, the Tribunal acknowledged that, unlike other investment treaties, the ECT makes no mention of any principle of "clean hands", or any requirement that investments be made legally. Notwithstanding the absence of treaty language, the Tribunal noted that it is a general principle of international law that an investment will not be protected if made in bad faith or in contravention of the host state's law. However, it declined Russia's request to extend the principle's application to post-investment conduct in the absence of the requisite level of international recognition and consensus.
Notably, in a series of interim awards issued in 2009, the Tribunal had already dismissed Russia's argument that the Tribunal lacked any jurisdiction under the ECT because, although Russia had signed the treaty, it had never been ratified.
The Tribunal held that Russia's actions were part of a targeted effort to bankrupt Yukos and appropriate its assets.
In its analysis of Article 13(1), the Tribunal relied on the concepts of legitimate expectations and proportionality. The Tribunal recognised the impropriety of Yukos' conduct, observing that the claimants should have expected some form of adverse reaction from Russian authorities for their tax optimisation schemes. However, the extremity of Russia's actions went far beyond these expectations. Ultimately, while there was no explicit expropriation of Yukos' or its shareholders' assets, Russia's measures nevertheless had an effect "equivalent to nationalisation or expropriation". The Tribunal then considered whether the expropriation was lawful, referring to the four ECT requirements (public interest; non-discrimination; due process; and adequate compensation), again finding in the claimants' favour. On public interest, the Tribunal considered the destruction of Yukos, as Russia's largest taxpayer, to be "profoundly questionable" and primarily in the interest of Rosneft, which took over Yukos' principal assets "virtually cost-free". On due process, the Tribunal held that Russian courts had "bent to the will of Russian executive authorities to bankrupt Yukos ... and incarcerate a man [Mr Khodorkovsky, Yukos' principal shareholder] who gave signs of becoming a political competitor".
Following the Tribunal's finding of unlawful expropriation, it was deemed unnecessary to decide on any breach of FET.
To calculate compensation, the Tribunal observed that, while the ECT specified the date of expropriation as the "proper valuation date", this was only relevant to "lawful" and not necessarily "unlawful" expropriation. Compensation should therefore be assessed from either the date of expropriation or the award – whichever is more favourable to the claimants. The more favourable valuation date was held to be that of the award.
Exercising its wide discretion, the Tribunal held that Yukos' own impropriety was indeed relevant to damages. As a result of "material and significant mis-conduct" by the claimants and Yukos, damages were reduced by 25%. The Tribunal considered this apportionment of responsibility to be fair and reasonable in the circumstances and cited Occidental v Ecuador (ICSID, ARB/06/111) in support of its approach.
The Tribunal also concluded that Russia should bear the full costs of the arbitration. On legal fees, the Tribunal acknowledged that the parties' fees were unsurprisingly high given the complexity of the case. However, it reduced the award on fees by 25% on the basis that some of the claimants' claims were excessive, and that their damages experts were of limited assistance.
Comment: Enormous damages and media coverage aside, the Yukos decision is worthy of comment for many reasons:
  • procedurally, it is noteworthy that, although the three arbitrations were not consolidated, the parties appointed the same tribunal in each and the arbitrations were heard in parallel;
  • interestingly, Russia contended that the actions of both Rosneft and the bankruptcy administrator were not attributable to the State. After an extensive review of the facts, the Tribunal concluded they were, citing the fact that President Putin had made statements indicating Russia's acceptance of responsibility for the auction of YNG, and Rosneft's acquisition of the same;
  • the ECT's tax carve-out is a complex provision. Notably, the Tribunal concluded that even if Article 21(1) had applied, any measures excluded by the carve-out would be brought back within the Tribunal's jurisdiction by the Article 21(5) claw‑back provision. The Tribunal also held that any referral to the "Competent Taxation Authorities" within the meaning of this latter provision would clearly have been futile;
  • the Tribunal's considerations of the international doctrines of "unclean hands" and contributory fault (which reduced damages by 25%) are likely to attract significant attention and may be an approach which is followed in future investment treaty cases;
  • the Tribunal also gave extensive consideration to calculating the value of the investments and interest. On interest, the Tribunal awarded simple pre-award interest and post-award interest compounded annually; and
  • overall the Tribunal's robust upholding of the protections of the ECT with respect to taxation measures is likely to make the treaty an attractive option for investors who wish to contest those measures through investment treaty arbitration.
Notably, on 31 July, the European Court of Human Rights (ECtHR) issued its judgment on a parallel case brought by Yukos (Application No 14902/04), ordering Russia to pay EUR 1.866 billion directly to all former Yukos shareholders for violating their rights to property (Article 1 of Protocol 1 to the European Convention on Human Rights (the Convention)) and to a fair hearing (Article 6 of the Convention). The ECtHR referred to the parallel ECT arbitrations but only did so to acknowledge that the decision remained pending, thus obviating the need to engage with issues of conflicts or double compensation arising between the two claims.
Russia has indicated that it will seek to appeal both the UNCITRAL award and the ECtHR judgment. On the ECtHR ruling, Russia has three months in which to lodge its appeal. Channels for challenging the UNCITRAL ruling are, however, very limited. Meanwhile, the Yukos shareholders are already considering their enforcement options – which have the potential to complicate further this already protracted dispute.