On 28 July 2014, the Permanent Court of Arbitration in the Hague published a final award in an Energy Charter Treaty (ECT) arbitration that has been active for the past decade, ordering the Russian Federation (Russia) to pay damages and costs of approximately US$50 billion (which roughly equates to the Gross Domestic Product (GDP) of Costa Rica)1 to three controlling shareholders (Claimant Shareholders) of OAO Yukos Oil Company (YUKOS), as compensation for the expropriation of YUKOS by Russia.2
It is reported as the largest arbitral award ever made.
This alert provides a brief introduction to the ECT, with particular emphasis on how the ECT can be used as a powerful tool for protecting energy sector investors against the actions of host States and for obtaining compensation in respect of losses resulting from such actions.
We use the example of the YUKOS arbitration to explain some of the procedures involved.
A brief summary of the YUKOS arbitration
In the YUKOS arbitration, Russia was found to have failed to treat the Claimant Shareholders' investments in YUKOS (one of the largest oil companies in Russia at the time) in a fair and equitable manner, on a non-discriminatory basis, and was also found to have expropriated those investments. Amongst other things, the Claimant Shareholders complained of criminal prosecutions (against YUKOS employees and professional advisors), harassment of YUKOS and its related persons, tax reassessments, fines, asset freezes, the forced sale of YUKOS' core oil production asset and other measures culminating in the bankruptcy of YUKOS in August 2006.
One of the central allegations, by the Claimant Shareholders, was that Russia's actions were politically motivated, due to the participation in Russian opposition politics by Mr Khodorkovsky, who was the Chief Executive Officer of YUKOS.
What is the Energy Charter Treaty?
The ECT is a multinational treaty which provides a legal framework for long term cooperation in the energy sector. It has been signed by more than 50 States and came into force on 16 April 1998. The treaty is legally binding, including its dispute resolution procedures.
The ECT emerged in the early 1990s from the dissolution of the USSR which brought about fundamental changes in world politics and renewed interest in energy cooperation between the West and the States of the former USSR. With the fragmentation of the previously centrally controlled energy transit system stretching from Central Asia to Eastern Europe, an inter-governmental agreement was necessary to provide stability that would ensure the continued trade and transit of energy.
The ECT deals with all forms of international energy cooperation and essentially addresses the following four issues – investment, trade, transit and energy efficiency.
- With regards to trade, the ECT seeks to achieve non discriminatory trade in energy materials, products and energy related equipment based on WTO rules.
- With regards to transit, the ECT seeks to develop a regime of commonly accepted legal principles covering transit flows of energy resources, both hydrocarbons and electricity, crossing at least two national boundaries.3 These commonly accepted principles are freedom of transit (without unreasonable delays, restrictions or charges) and non-discrimination (on the basis of origin, destination or ownership of energy products).
- With regards to energy efficiency, the ECT provides that each contracting State should strive to minimise, in an economically efficient manner, harmful environmental impacts coming from all operations within the energy cycle in its area.
- With regards to investment, which was the focus of the YUKOS arbitration, the ECT seeks to ensure the creation of a level playing field for energy sector investments throughout the Charter's contracting States by reducing to a minimum the non-commercial risks associated with energy sector investments. The ECT establishes an obligation of non-discrimination and non-expropriation in relation to investments and a contracting State undertakes to extend national treatment4 or most favoured nation treatment5 (whichever is more favourable) to investments in its energy sector.
The dispute resolution provisions of the ECT in Article 26 provide practical efficacy to the goals of the ECT, providing foreign investors with the direct right to sue their host States through arbitration. However, it is important to appreciate that there are limitations to this right.
What rights are protected? Firstly, foreign investors can only sue for breaches of Part II of the ECT on "Investment Promotion and Protection".6 The provisions of this Part include:
- The right of investors to employ key personnel of their choice in relation to energy related investments.7
- The obligation on the State to pay compensation to investors for losses with respect of investments arising from wars, civil disturbances or similar events.8
- Prohibiting expropriation or equivalent measures except under specified conditions and subject to the payment of prompt, adequate and effective compensation.9
- Rights of investors to make currency transfers in relation to investments.10
Cooling off period Secondly, before commencing proceedings, the investor and the host State must attempt to resolve their dispute amicably for a three month period.11
Choice of arbitration procedure Thirdly, a foreign investor must choose to submit its case to one of three arbitration rules and/or institutions:
- The International Centre for the Settlement of Investment Disputes (ICSID).
- The Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL).
- The Arbitration Institute of the Stockholm Chamber of Commerce (SCC).
In the YUKOS arbitration, the parties chose to submit their cases to arbitration under the UNCITRAL Arbitration Rules, with the Permanent Court of International Arbitration providing registry support and facilities.
What investments are protected?
The term "investment" is defined at Article 1(6) of the ECT and gives a very broad, non-exhaustive, asset-based definition of an investment which includes the following:
- Tangible and intangible, and moveable and immovable property, and any property rights such as leases, mortgages, liens and pledges.
- A company or business enterprise, or shares, stock, bonds and other debt of a company or business enterprises.
- Claims to money and claims to performance pursuant to contract having an economic value and associated with an investment.
- Intellectual property.
- Any right conferred by law or contract or by virtue of any licences and permits.
The YUKOS arbitration concerned, principally, the investment in shares, although in many other ECT arbitrations, the disputes relate to licence.
Which investors qualify for protection under the ECT?
An investor under the ECT means a natural person having the nationality of, or who is permanently residing in, a contracting State to the ECT or a company organised in accordance with the laws of a contracting State to the ECT. Under international law, nationality is defined by each State's domestic laws. The Claimant Shareholders in YUKOS all had the advantage of being nationals of a contracting State.
The provision of particular interest to energy investors is the expropriation provision in the ECT (mentioned above) which is almost always invoked in arbitrations under the ECT. Expropriation is a complex concept under international law and the definition provided in the ECT is general so provides little guidance on its meaning. However, it is clear that, in addition to straightforward, forcible taking of assets by the State, regulatory measures by the State may amount to indirect expropriation if it destroys the value of an investment. Examples of expropriation – in the energy sector and outside it – include the following:
- Expropriation of a factory – this was deemed both a direct and indirect expropriation. There was indirect expropriation of patents and contracts of a company which did not own the factory because it had rights of management in the expropriated factory.12
- Increased taxes and royalties by a State.13
- A hotel project which had proceeded substantially when the authorities issued a stop work order, demolished part of the project and arrested and expelled the investor. This was deemed expropriation of contractual rights in the project and expropriation of the value of an investor's interest in the local company which was responsible for the project.14
- A local "temporary manager" is put in charge of a project by the host State - this is an interference with property rights to the extent that these rights are rendered useless.15
- Revoking of a host State's free zone status without a formal taking of property.16
- Denial of a construction permit despite assurance by the government that the investor's project complied with all relevant environmental and planning regulations.17
- Export bans.18
Enforcement and appeal of ECT awards
Article 26(8) of the ECT provides that ECT arbitral awards will be final and binding upon the parties. The ECT also provides that such award may include interest and the host State must pay monetary damages in lieu of any other remedy granted.
The fact that an ECT award is final and binding means that it cannot be appealed. It may be challenged, however, depending on the seat of the arbitration. Challenges are normally limited to issues such as lack of tribunal jurisdiction or where there has been a serious irregularity in the process. In the case of the YUKOS arbitration, the seat is the Hague so any primary challenge should be made to the Netherlands Courts, subject to time limits.
If there are no grounds to challenge, then an ECT award should be enforceable, although how it is enforced depends, once again, on the seat and the arbitral rules adopted.
If the arbitration was conducted under the UNCITRAL rules – as in YUKOS – or SCC rules, the successful party would need to enforce its award under the New York Convention which requires States which are a party to that Convention to enforce foreign arbitral awards in their courts (again, subject to a limited number of exceptions which deal, essentially, with breaches of natural justice during the arbitration).
If the arbitration is conducted under the ICSID rules, the arbitral award will be enforceable under the ICSID Convention which obliges contracting parties to the Convention to recognise the awards as if they were judgments in the courts of the State in question.
In order to challenge an ICSID Award (where there is no local seat), the ICSID rules provide for a separate annulment procedure whereby an ad hoc committee consisting of three arbitrators will review the award.
It seems that Russia is very much considering a challenge to the award, with the media suggesting that it will allege that the tribunal lacked jurisdiction to determine (at least some of) the claims before it. It has also suggested the tribunal was "one sided" and "politically biased". As most arbitration lawyers will know, challenging final and binding arbitral awards is far from easy. If it makes the challenge in the courts of the Netherlands, it may well take 12 months for the challenge to be decided.
In the meantime, Russia has been given 180 days to pay the award before interest starts to accrue. Challenging the award is unlikely to prevent the rights of the Claimant Shareholders to enforce the award in jurisdictions around the world where Russia has assets.
1. World Bank, Gross Domestic Product 2013 (http://data.worldbank.org/data-catalog/GDP-ranking-table).
2. Hulley Enterprises Limited (Cyprus) v. The Russian Federation, 18 July 2014, PCA Case No. AA 226; Yukos Universal Limited (Isle of Man) v. The Russian Federation, 18 July 2014, PCA Case No. AA 227; Veteran Petroleum Limited (Cyprus) v. The Russian Federation, 18 July 2014, PCA Case No. AA 228.
3. Article 7, ECT.
4. In summary, this means receiving the same treatment as the nationals of the host State.
5. In summary, this means receiving the same treatment as the national of another signatory State to the ECT.
6. See Articles 10 to 17 of the ECT.
7. ECT, Article 11.
8. ECT, Article 12.
9. ECT, Article 13.
10. ECT, Article 14.
11. ECT, Articles 26(1) and 26(2).
12. Factory at Chorzow (Germany v. Poland), Judgment, 15 May 1926, PCIJ Ser. A, No.7 (1927).
13. In the matter of Revere Copper and Brass Inc. v. Overseas Private Investment Corporation, Award, 24 August 1978, 56 ILR 268.
14. Biloune and Marine Drive Complex Ltd v. Ghana Investments Centre and the Government of Ghana, Award on Jurisdiction and Liability, 27 October 1989, 95 ILR 184.
15. Starrett Housing v. Iran, 19 January 1981, 1 Iran-US CTR 9.
16. Goetz and others v. Burundi, Award, 2 September 1998, 6 ICSID Reports 5.
17. Metalclad Corp. v. United Mexican States, Award, 30 August 2000, 5 ICSID Reports 209.
18. S.D. Myers Inc. v. Canada, Partial Award, 12 November 2000, 40 ILM 1408 (2001).
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.