Canada: Gold Reserve And Exxon Mobil Awarded Significant Compensation In Two International Arbitration Rulings Against Venezuela

Two prominent cases against Venezuela tried before international arbitral tribunals have recently resulted in significant compensation being awarded to both companies whose assets were expropriated by the country.

On September 22, 2014, a tribunal (the "GR Tribunal") established under the rules of the International Centre for Settlement of Investment Disputes ("ICSID") issued a significant monetary award – US$740 million – in favour of the Canadian mining company Gold Reserve Inc. ("Gold Reserve") against the Bolivarian Republic of Venezuela ("Venezuela") for violations under the treaty between Canada and Venezuela for the promotion and protection of investments (the "Canada-Venezuela FIPA" or the "FIPA").

Then, on October 9, 2014, another ICSID Tribunal (the "EM Tribunal") awarded the American oil and gas company Exxon Mobil an even greater monetary award – US$1.6 billion – against Venezuela. The claim was made under a bilateral investment treaty between the Netherlands and Venezuela (the "Netherlands-Venezuela BIT"), as one of the Exxon Mobil subsidiaries involved in the proceeding was incorporated in the Netherlands.

These two recent arbitration awards are among the many yet to arise out of actions taken by the government of former president Hugo Chávez against foreign companies operating in Venezuela. Currently, Venezuela has 26 pending cases against it before the ICSID. Despite the fact that Venezuela withdrew from the ICSID in January 2012, the ICSID may still have jurisdiction to hear claims against Venezuela depending on the wording of the bilateral investment treaties.

This bulletin will explain both awards as well as their importance for future investor-state arbitration cases.

Gold and Copper Mining: Gold Reserve Inc. v. The Bolivarian Republic of Venezuela

Background of the Case

Gold Reserve is a company incorporated in Yukon, Canada. In 1992 and 1993, an American predecessor to the company acquired a gold and copper project located in south-eastern Venezuela, which included the Brisas concession and the Unicornio concession (the "Brisas Project"). In 2008, after the company had invested approximately US$300 million in project development and was ready to start construction, the Brisas Project ran into problems with the Venezuelan government. In January 2009, Venezuela's former President Hugo Chávez announced the government's intention to take over the Brisas Project, as part of a plan to turn private concessions into joint ventures between the government and private firms. Subsequently, Venezuela suspended mining activities in the Brisas concession, terminated the Brisas and the Unicornio concessions, seized Gold Reserve's assets and occupied the site of the Brisas Project.

On October 21, 2009, Gold Reserve filed a claim with the ICSID for damages arising from violations of the Canada-Venezuela FIPA regarding the Brisas and Unicornio mining concessions. Gold Reserve claimed that Venezuela violated its obligations to provide fair and equitable treatment, most favoured nation treatment, and not to expropriate property without compensation. The company sought US$1.7 billion in compensation.

As is usual in these cases, Venezuela objected to the GR Tribunal's jurisdiction. Venezuela argued that Gold Reserve was not an "investor" under the FIPA because it was not a bona fide Canadian company but merely a shell company for the purposes of obtaining protection under the FIPA for its American parent. Venezuela also argued that Gold Reserve had not "made" an investment in Venezuela as it gained its shares in the Venezuelan company that directly owned the Brisas project through a restructuring rather than an outright purchase.

The GR Tribunal rejected both of Venezuela's objections, finding that there is no "genuine link" test in the FIPA; if a claimant company is incorporated in Canada, then it meets the "incorporation" test, and that the acquisition of shares through restructuring as opposed to purchase is sufficient for an investor to have "made" an investment.

GR Tribunal's Ruling

The GR Tribunal rejected Gold Reserve's claims that its rights were violated under the full protection and security, and expropriations obligations of the FIPA. However, it agreed Venezuela violated its right to "fair and equitable treatment" as provided by Article II(2) of the FIPA, and awarded Gold Reserve compensation on the basis of this violation.

In applying the fair and equitable treatment standard, the GR Tribunal looked first to Gold Reserve's legitimate expectations as to the continued validity of its concessions and that, when the time came, it would be able to obtain the necessary construction permits. An interesting facet of this case is that Gold Reserve was able to establish its legitimate expectations primarily through Venezuela's conduct during the history of the projects rather than through the more typical specific investment inducing, quasi contractual representation. Whether a government's conduct is considered to be fair and equitable is fact-dependent, and so the impact of the GR Tribunal's approach to the issue will have to be determined on a case by case basis.

The finding of a violation did not depend only on a violation of legitimate expectations, but was the cumulative effect of a series of actions and inactions on the part of Venezuela. In addition to finding a violation of the fair and equitable standard on the basis of Gold Reserve's legitimate expectations, the GR Tribunal relied on Venezuela's failure to provide Gold Reserve an opportunity to be heard, the failure of Venezuela to respect due process rights regarding the termination of the concessions, and the considerable evidence suggesting that Venezuela's actions were targeted and politically motivated rather than being a legitimate policy response to a matter of public concern.

Having found that "the number, variety and seriousness of the breaches make the fair and equitable treatment violation by [Venezuela] particularly egregious", the GR Tribunal reasoned that the compensation due to Gold Reserve for such breaches "should reflect the seriousness of the violation" and that "fair market value" was appropriate, as was the application of the "loser pays" principle for legal costs. In the end, Venezuela was ordered to pay US$713 million in damages plus interest and US$5 million for legal and technical costs.

Oil & Gas: Mobil Corporation et al. v. The Bolivarian Republic of Venezuela

Background of the Case

During the 1990s, Mobil Corporation (now ExxonMobil), ("Exxon Mobil"), made investments in the Cerro Negro and La Ceiba projects in Venezuela (the "Projects") through various subsidiaries. At that time, Venezuala had an "Oil Opening" policy to attract foreign companies that could provide the infrastructure to exploit untapped oil reserves. Under this policy, the state-owned oil company Petróleos de Venezuela, S.A. ("PDVSA"), offered reduced royalty and income tax rate rates within special agreements to make foreign investment more attractive. Despite these agreements, Venezuela increased the royalty and income taxes applicable to Exxon Mobil's investments in the Projects from 2004 to 2007. In 2007, Venezuela sought to migrate the Projects to new mixed companies that would transfer control to PDVSA. After Exxon Mobil did not agree to the terms Venezuela proposed, the State expropriated the Projects.

On September 6, 2007, Exxon Mobil brought an arbitration claim against Venezuela to the EM Tribunal, alleging that Venezuela had violated its rights to fair and equitable treatment and from expropriation without compensation under the Netherlands-Venezuela BIT. The company sought US$14.5 billion in compensation for the Cerro Negro project and US$179 million for the La Ceiba project.

EM Tribunal's Ruling

The EM Tribunal accepted Exxon Mobil's claim for a violation of its right to fair and equitable treatment in respect of production and export curtailments, but rejected it in respect of royalty increases and the expropriation itself. The EM Tribunal allowed Exxon Mobil's claim for expropriation.

Both parties agreed that the appropriate time to assess damages was June 27, 2007, the moment immediately after negotiations between the parties failed and before the expropriation. For Cerro Negro, the calculation also had to take into account an estimate of the discounted cash flow that would have been generated by the investment over its remaining life but for the intervention by Venezuela. The parties disagreed on specific facts including: net cash flow, volume of production, oil price, future revenues, effect of royalties and extraction tax, cost of operation and capital investment, special contributions, income tax, discount rate, and price cap. Since La Ceiba was still in a phase of development, the Tribunal ruled that the discounted cash flow method was inapplicable to the assessment of the quantum of damages for that interest. On valuation, the EM Tribunal stated:

"307. Article 6 of the BIT requires that "just compensation" be paid to the Claimants. Such compensation must "represent the market value of the investments affected immediately before the measures were taken or the impending measures became public knowledge, whichever is the earlier". In the present case, the market value must be determined immediately after the failure of the negotiations between the Parties and before the expropriation, i.e., on 27 June 2007, and it must correspond to the amount that a willing buyer would have been ready to pay to a willing seller at the time in order to acquire the expropriated interests.

308. With respect to Cerro Negro, the Parties agree that this evaluation must be made in accordance with a discounted cash flow (DCF) analysis for the Claimants' lost interests. Accordingly, the Parties have evaluated the net cash flows that would have been generated by the investment over its remaining life, i.e., until June 2035, and discount them to their present value. However, they diverge in their determination of the net cash flows and the discount rate."

Ultimately, Venezuela was ordered to pay a total of US$1.6 billion: US$9.042 million for the production and export curtailments, US$1.4 billion for the expropriation of Cerro Negro project, and US$179.3 million for the expropriation of La Ceiba project, plus interest.

The award takes into account the amount awarded to Exxon Mobil in a 2012 settlement at the International Chamber of Commerce, as Exxon Mobil was not entitled to double recovery fee for the same loss.

What is the Importance of these Awards for Future Cases?

These cases reaffirm that investment treaties provide investors some protection from political risk by enabling them to get enforceable, even insurable judgments for gross violations of the standards of treatment expected of states in international law. They also provide some guidance to investors on how to access the protections these investment treaties offer.

In particular, they also show:

  • international investments can be structured to take advantage of the protections offered by investment treaties;
  • the importance of determining what specific representations an investor should be looking for to enhance the protections offered by the treaty;
  • the importance of keeping track of interactions with the state over the project's life; and
  • the importance of being an upstanding corporate citizen to risk mitigation efforts. (Neither case involved significant claims by Venezuela that its conduct was justified because of the investor's misdeeds).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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