Russian Federation: Tribunal In Yukos Case Holds Russia Is Bound By Energy Charter Treaty

Last Updated: 30 January 2010
Article by Matthew Saunders

On 30 November 2009, an international ad hoc arbitral tribunal sitting at the Permanent Court of Arbitration in The Hague ruled that Russia is bound by the provisions of the Energy Charter Treaty (ECT), an international treaty that Russia has signed but not ratified. The preliminary ruling was made in arbitration proceedings underway against the Russian Federation for the alleged expropriation of the assets of the former Yukos Oil Company.1

The claimants, the majority shareholders of the former Yukos Oil Company – Hulley Enterprises Ltd. (Cyprus), Yukos Universal Ltd. (UK - Isle of Man) – as well as Veteran Petroleum Ltd. (Cyprus), a pension fund established for the benefit of former Yukos employees, allege that the Russian Federation unlawfully expropriated their investment in the Yukos Oil Company through the bankruptcy and forced sale of its main assets by the Russian government. The claimants are seeking compensation in an amount near US $100 billion, making this claim one of the largest in the history of international arbitration.

The Energy Charter Treaty

The ECT is a multilateral instrument that, among other things, provides substantive protections to investors in the energy sector, including protection against unlawful expropriation and discrimination against energy investments. The ECT also contains dispute resolution provisions allowing investors to bring arbitration claims against ECT contracting states for violations of the investors' rights under the ECT. In the event of breach of those provisions, Article 26 of the ECT provides for binding investor/state arbitration. The investor can elect to submit the dispute for international arbitration under the Rules of the International Centre for the Settlement of Investment Disputes (ICSID), the ICSID Additional Facility Rules, to a tribunal established under the UNCITRAL Rules or to the Arbitration Institute of the Stockholm Chamber of Commerce.

Ratification and Provisional Application

The process of concluding an international treaty generally involves three stages: signature, ratification and entry into force. Signature by a state usually expresses the intention of that state to be bound by the treaty, subject to domestic ratification procedures. Ratification is an international act whereby the state establishes its consent to be bound by the treaty2, but for most states, this requires authorisation of the treaty by the legislature, for example by passing a bill.

Russia signed the ECT in 1994 but has never ratified it (pending negotiation of additional areas of regulation on the trade of nuclear material, an additional investment protocol and a transit protocol). However, Article 45(2) of the ECT provides that each signatory state agrees to apply the ECT provisionally pending its entry into force for that state (known as "provisional application"), to the extent that provisional application is not inconsistent with that state's own constitution, laws or regulations.3 Although the ECT permits signatories to make a declaration not to accept provisional application pending ratification,4 Russia made no such reservation upon becoming a signatory.

Provisional application, although commonly provided for in intergovernmental treaties, is unusual in this context because of the significant investment protection provisions in the ECT. If the ECT is interpreted as having its full effect before ratification, it means that a state may be fully bound by the treaty, including the investment protection provisions, without the treaty having been approved by the legislature of that state. Provisional application of the ECT has caused particular uncertainty in relation to whether a state that has not ratified the ECT could be bound by the international arbitration clause in Article 26.

Decisions on Provisional Application

The first known award addressing the interpretation of the provisional application provisions in the ECT was made in an arbitration in which DLA Piper acted, Ioannis Kardassopoulos v Georgia.5 In this case, an ICSID tribunal held that Article 45 should be interpreted as meaning that each signatory state is obliged, even before the ECT has formally entered into force, to apply the whole ECT as if it had already done so.

At the time of writing, the text of the preliminary ruling of 30 November 2009 in the Yukos case is not publicly available, but it reportedly deals with issues relating to the Tribunal's jurisdiction and the admissibility of the claims. The claimants had argued that as a signatory Russia was bound to observe the ECT and its rules on protecting investments. Russian officials have repeatedly stated that the Yukos case was a simple tax matter and that in any event the ECT is not enforceable against Russia. According to the claimants, the tribunal ruled that in signing the ECT Russia had accepted provisional application and at the time the events giving rise to the Yukos dispute occurred, Russia was fully bound by its provisions including those relating to arbitration. Having found that it has jurisdiction to hear the dispute, the tribunal will now proceed to consider the merits of the claimants' expropriation claim.

The tribunal's decision follows in the wake of Russia's announcement in August 2009 that it would withdraw from the ECT with effect from 18 October 2009. Russia's withdrawal will have no bearing on the Yukos case, because the events giving rise to the dispute predate Russia's withdrawal.

A further issue is whether Russia will continue to remain bound in respect of certain provisions of the ECT despite its recent withdrawal. The ECT provides that in the event that a signatory terminates provisional application, "its obligation to apply Parts III and V with respect to any Investments made in its Area during such provisional application by Investors of other signatories shall nevertheless remain in effect with respect to those Investments for twenty years following the effective date of termination..."6

In addition, by clarifying the effect of provisional application, the 30 November decision could have significant implications for energy investments made in Russia, as well as in other countries that have signed but not ratified the ECT.

Footnotes

1. Yukos Universal Ltd. (UK – Isle of Man) v. Russian Federation; Hulley Enterprises Ltd. (Cyprus) v. Russian Federation; Veteran Petroleum Trust (Cyprus) v. Russian Federation. Ad hoc UNCITRAL Arbitration Rules; arbitration administered by the Permanent Court of Arbitration (PCA) in The Hague. Arbitrators: L. Yves Fortier (chair); Charles Poncet (replacing Daniel Price); Stephen Schwebel.

2. Article 2(1)(b) of the Vienna Convention on the Law of Treaties

3. ECT, Article 45(1)

4. ECT, Article 45(2)

5. Ioannis Kardassopoulos v Georgia, ICSID Case No. ARB/05/18

6. ECT, Article 43(3)

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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