SCC tribunal upholds expropriation claim in Yukos arbitration

Practical Law Legal Update 6-504-4411 (Approx. 6 pages)

SCC tribunal upholds expropriation claim in Yukos arbitration

by PLC Arbitration

Background

The bilateral investment treaty (BIT) between the UK and Russia contains the following relevant provisions:

Article 1(a) defines investment as every kind of asset including "shares in ... a company or business enterprise".
Article 1(d)(ii) defines investor as "any corporations, companies ... incorporated or constituted under the law in force in the territory of [a] Contracting Party".
Article 3 provides that neither contracting party shall subject investments of the other contracting party to treatment less favourable than that which it accords to investments of any third state (the most favoured nation (MFN) clause).
Article 5(1) provides that investments of investors of either contracting party shall not be nationalised or expropriated except for a purpose which is in the public interest and is not discriminatory and against the payment of adequate and effective compensation.
Article 5(2) clarifies that where a contracting party expropriates the assets of a company incorporated under the law in force in its own territory, and in which investors of the other contracting party have a shareholding, the provisions of Article 5(1) shall apply.

For more information on the definitions of investor and investment, see Practice notes, What is an investor for the purposes of investment treaty arbitration? and The definition of investment in international investment law.

For detailed discussion about expropriation, see Practice note, Expropriation in international investment law.

For discussion about MFN clauses, see Practice note, How most favoured nation clauses in bilateral investment treaties affect arbitration.

Facts

The claimant RosInvestCo (C), an English company, bought seven million ordinary shares in OAO NK Yukos Oil Company OJSC (Yukos), a Russian oil company, on two occasions on 17 November and 1 December 2004. C was an indirect subsidiary of Elliott Associates LP, a US hedge fund. C alleged that the Russian Federation (R) had expropriated all of the assets of Yukos by a series of measures between 19 December 2004 and 15 August 2007. Specifically, it alleged that R had expropriated Yukos' assets by:

Organising an auction which resulted in the transfer of all of Yukos' common shares in Yuganskneftegaz (YNG), Yukos' principal production facility, to Baikalfinansgroup (BFG), which was acquired by the Russian state-owned oil company, Rosneft four days after the auction.
Forcing Yukos into bankruptcy, after which Yukos' remaining assets were sold in a series of bankruptcy auctions, leaving it with no assets at all.

These measures were preceded by unfavourable tax assessments which were carried out by the Russian Tax Ministry in December 2003 and which concluded that Yukos owed some USD$20 million in back taxes, penalties and interest. C claimed that Yukos was not given an opportunity to pay the tax claims and that the actions taken by R were discriminatory and were not bona fide.

C claimed that R had breached Articles 5(1) and 5(2) of the UK/Russia BIT and commenced arbitration under the rules of the Arbitration Institute of the Stockholm Chamber of Commerce (SCC).

In October 2007, the tribunal made an award on jurisdiction. It held that, although expropriation claims fell outside the scope of the arbitration clause in the UK/Russia BIT, C could rely on the wider arbitration clause in the BIT between Denmark and Russia, by virtue of the MFN clause (Article 3) in the UK/Russia BIT.

During the merits phase of the arbitration, R raised further jurisdictional objections, including that:

C could not rely on the arbitration clause in the Denmark/Russia BIT, because that clause excluded taxation claims.
C was not an investor for the purposes of the UK/Russia BIT because it was only a nominal owner and not the beneficial owner of the Yukos shares at the date of the alleged expropriation. C had transferred the economic interest in the shares to another company in the same group (Elliott International) under intra-group "participation agreements" and did not become an investor until the termination of the participation agreements in January 2007, which was after the events of which C complained.
The tax assessments C complained of occurred pre-investment and therefore the tribunal did not have jurisdiction to review them.

R also argued that the measures it had taken were legitimate and were not discriminatory.

Decision

The tribunal confirmed its decision on jurisdiction and held that there had been an unlawful expropriation in breach of Article 5 of the UK/Russia BIT.

Jurisdiction

The tribunal rejected each of R's jurisdictional objections as follows:

R's argument that C could not rely on the arbitration clause in the Denmark/Russia BIT because it excluded claims based on taxation was irrelevant: the tribunal had to consider whether there had been an expropriation by a cumulative combination of measures, not just taxation. The tribunal acknowledged that there was an argument that the arbitration clause in the Denmark/Russia BIT should be imported in its context, that is subject to the exclusion of taxation claims. However, it did not have to take a view as to the validity of that argument in this case because the claim related to other measures in addition to taxation.
C had standing to claim under the UK/Russia BIT: it was a company incorporated under the laws in force in the UK and it had purchased shares in Yukos. It was, therefore, prima facie an investor in terms of Article 1(d)(ii) of the BIT, which was very wide. The fact that C might only have been a nominal owner of the Yukos shares did not preclude the definition of "investor" from applying to C.
The definition of "investment" in the UK/Russia BIT included "shares in ... a company". Therefore, a purchase by an investor of shares in a company incorporated in a host state was an investment in the territory of that host state. Prima facie, C held an investment under the terms of the BIT. It did not make any difference if the shares were bought through a broker and ownership recorded via a broker account. Further, it was immaterial whether C was the beneficial owner of the shares, although that might be relevant to the assessment of any damages that might be awarded.
The major alleged acts of which complaint was made all occurred after C became an investor. Therefore, the tribunal had jurisdiction rationae temporis. In addition, the tribunal could review conduct which took place before C's investment when considering whether R breached the BIT and damaged C's investment: R's pre-investment conduct was inextricably linked with the acts alleged to be in breach of the BIT. However, the timing of C's share purchase would be relevant to the tribunal's consideration of the quantum of any damages awarded.

Did the alleged measures constitute unlawful expropriation?

The measures alleged to constitute an unlawful expropriation were the YNG auction and the bankruptcy auctions, all of which occurred after C became an investor. In addition, the tribunal took into account conduct which pre-dated the investment. The question was whether, cumulatively, all of the measures taken by R could be considered a breach of Article 5 of the UK/Russia BIT.

The tribunal concluded that as a result of the measures taken by R, Yukos was deprived of its assets and this affected C's shares in Yukos. As such there was an expropriation, which could only be lawful if the conditions in Article 5(1) were satisfied, namely that the expropriation was in the public interest, non-discriminatory, in accordance with due process and accompanied by payment of compensation.

Even if it could be argued that, in the Russian government's judgement, it was in the public interest to take Yukos' assets, R had never claimed or established that this was so. Further:

R's application of its tax laws and the tax assessments which took place in December 2003 were discriminatory, in that Yukos was treated differently to its competitors, and therefore could not be considered as bona fide.
The YNG auction was organised in such a manner as to ensure that the state ultimately took control of Yukos' main asset, the YNG shares. As such, the tribunal was convinced that the YNG auction was "rigged".
Although the bankruptcy auctions did not appear to have been conducted contrary to Russian law, the tribunal's general impression was that they fitted in with the obvious intention of the totality of the scheme to deprive Yukos of its assets, as the application for bankruptcy was conducted in association with Rosneft.
It was clear that R had not offered or paid any compensation to C for the taking of the shares.

The tribunal concluded that the cumulative effect of the measures taken relating to Yukos constituted an unlawful expropriation under Article 5 of the UK/Russia BIT.

Assessment of damages

When assessing the quantum of damages, the tribunal had to take into account that C had known that Yukos was in difficulty when it bought the shares in 2004 and, as such, had made a speculative investment. It would be unjust to award damages on the basis of a best case valuation, based on the hypothetical value of Yukos' shares if the tax assessments, auctions and bankruptcy had not occurred. It accepted R's expert evidence that at the time when C purchased the shares in 2004, the market had already taken into account the effect of R's measures and any possibility that Yukos would profitably survive beyond the enforcement of those measures.

While the participation agreements did not prevent C from being an investor under the definition of the UK/Russia BIT, their effect was that any risks regarding the investment were transferred to Elliott Associates during the validity of the agreements. C had no real economic interest of its own in the Yukos shares until the participation agreements were terminated. Therefore, the date that should be applied for the purposes of valuing the Yukos shares must be when C took over the risk at the end of the participation agreements, which was 24 January 2007. On that basis, the calculation of damages should be from 24 January 2007.

The tribunal concluded that the best reflection of the damages was the price C undisputedly paid to Elliott as the purchase price for the shares. This was USD$3.5 million.

The tribunal considered whether interest on that principal amount should be calculated on a simple or compound basis, by reviewing the conduct of C and Elliott. The tribunal decided that interest on the principal amount should be awarded at a "normal commercial rate", as proposed by the parties and envisaged by Article 5(1) in the case of a lawful expropriation. However, taking into account the speculative nature of the investment by C and its parent, Elliott, it would be unjust to apply compound interest to the damages at anything more frequent than an annual basis. It concluded that interest ought to be applied at LIBOR starting from 24 March 2007, namely 24 January 2007 plus the two-month grace period provided in Article 5(1).

Comment

This case is a good illustration of the wide scope of the definitions of "investor" and "investment" in many BITs. However, it is noteworthy that although the arrangements whereby C held the Yukos shares (effectively as a nominal shareholder) did not affect its standing to make a claim under the BIT or the issue of liability, they had a very significant impact on the damages awarded which were a fraction of those claimed.

This is the first decision on the merits in a series of arbitrations brought against R by Yukos shareholders. Although the award will not be binding on other tribunals, no doubt the finding of expropriation will be relied on by claimants in those other arbitrations, although R has applied to the Swedish courts to set aside the award.

Case

RosInvestCo UK Ltd v Russian Federation (SCC arbitration V(079/2005).

SCC tribunal upholds expropriation claim in Yukos arbitration | Practical Law