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ICSID tribunal considers Salini criteria
Practical Law UK Legal Update Case Report 9-525-4681 (Approx. 7 pages)
ICSID tribunal considers Salini criteria
by Alejandro I Garcia, Herbert Smith Freehills LLP
| Published on 27 Mar 2013 • International, USA (National/Federal) |
In Deutsche Bank AG v Sri Lanka (ICSID Case No ARB/09/02), an ICSID tribunal considered whether it had jurisdiction over a dispute relating to a hedging agreement. The decision adds to the ongoing debate as to the status of the Salini criteria.
Speedread
In an award dispatched to the parties on 31 October 2012 but only recently published, the majority of an ICSID tribunal concluded that it had jurisdiction under the Germany-Sri Lanka bilateral investment treaty (BIT) and the ICSID Convention over a dispute relating to a hedging agreement between Deutsche Bank and a 100% state-owned oil company. Further, the majority held that Sri Lanka was in breach of the BIT and awarded compensation in excess of US$60 million plus interest and legal fees (the latter in the region of US$8 million). The arbitrator appointed by Sri Lanka issued a dissenting opinion in which he disagreed with most of the conclusions of the majority.
Notably, in relation to the tribunal's jurisdiction under Article 25 of the ICSID Convention, the majority held that the so-called Salini test is not mandatory, but nevertheless used it as starting point in its jurisdictional analysis. The case adds to the ongoing debate as to the status of the Salini criteria. (Deutsche Bank AG v Sri Lanka, ICSID Case No ARB/09/02).
Background
Article 25 of the ICSID Convention provides that ICSID's jurisdiction extends to any legal dispute "arising directly out of an investment between a Contracting State [...] and a national of another Contracting State". "Investment" is not defined in the Convention. In Salini v Morocco (ICSID Case No Arb/00/04) (Decision on Jurisdiction, 23 July 2001), the tribunal identified five criteria indicative of the existence of an investment for these purposes, namely:
- A substantial commitment or contribution.
- Duration.
- Assumption of risk.
- Contribution to economic development.
- Regularity of profit and return.
Subsequent tribunals have applied these criteria flexibly, giving rise to an ongoing debate as to their status. For further discussion, see Practice note, Definition of investment in international investment law.
Facts
The dispute ultimately related to an oil hedging agreement dated 8 July 2008 concluded by Deutsche Bank AG and Ceylon Petroleum Corporation (CPC), Sri Lanka's 100% state-owned oil company.
The hedging agreement was concluded with a view to protecting Sri Lanka against rising oil prices and stipulated a "strike price" of US$112.50 per barrel of oil. In summary, if the price of the oil purchased by CPC was higher than the strike price, Deutsche Bank was to pay CPC the difference between the strike price and the price of the oil purchased by CPC, subject to a cap. Conversely, if the price of the oil purchased by CPC was lower than the strike price, then CPC was to pay the difference between the strike price and the price of the oil in issue. The hedging agreement was governed by English law and included a choice of forum clause submitting future disputes to the English court.
Oil prices rose immediately after conclusion of the hedging agreement and Deutsche Bank made payments to CPC pursuant to the strike price provisions. However, as of late July 2008, oil prices began to fall. As a result, CPC paid to Deutsche Bank US$1.65 million in October 2008 and US$4.5 million in November 2008. No further payments were received by Deutsche Bank. In early November 2008, Sri Lanka's Central Bank (Central Bank) initiated an official inquiry into the circumstances surrounding the conclusion of the hedging agreement.
On 26 November 2008, with a view to challenging the authority of CPC to conclude the hedging agreement, constitutional actions before the Supreme Court of Sri Lanka were commenced apparently by members of the public. On 28 November 2008, the Supreme Court issued an interim order directing, amongst other things, that all payments by CPC to Deutsche Bank and other banks under the hedging agreement be suspended.
On 3 December 2008, Deutsche Bank notified CPC of the termination of the hedging agreement. Due to the measures enacted by the Supreme Court, Deutsche Bank considered that if it did not terminate the hedging agreement, it would be exposed to the risk of having to make payments to CPC if the price of oil exceeded the strike price, but without the possibility of receiving payments if the oil prices went down.
On 16 December 2008, within the context of its inquiry, the Central Bank issued an order prohibiting any payments to Deutsche Bank under the hedging agreement.
On 6 January 2009, the Central Bank forwarded Deutsche Bank a report which concluded that the individuals who entered into the hedging agreement on behalf of CPC did not possess the necessary authority and that CPC had not followed relevant governmental procedures.
On 27 January 2009, the Supreme Court's interim order of 28 November 2008 was lifted. However, on the same day the Central Bank issued a press release indicating that its order of 16 December 2008, prohibiting payments in respect of the hedging agreement, remained in force.
In February 2009, Deutsche Bank commenced arbitral proceedings under the ICSID Convention against Sri Lanka arguing that the latter had violated a number of protections guaranteed under the Germany-Sri Lanka bilateral investment treaty (BIT):
- The fair and equitable treatment (FET) standard.
- The duty not to expropriate relevant investments.
- The duty to accord full protection and security to investments.
- The umbrella clause in the BIT.
In respect of the FET standard, Deutsche Bank argued that once oil prices dropped sharply in November 2008, the Central Bank and Supreme Court intervened to make it impossible for Deutsche Bank to be paid the monies owed under the hedging agreement.
Sri Lanka challenged the tribunal's jurisdiction. It argued that the hedging agreement was not an investment within the meaning of the BIT and Article 25 of the ICSID Convention.
Decision
The majority of the tribunal found that it had jurisdiction over the dispute under the BIT and the ICSID Convention. The majority also concluded that Sri Lanka was in breach of the BIT and awarded damages in the region of US$60 million plus interest, and US$8 million in respect of legal fees.
The arbitrator appointed by Sri Lanka, Mr Makhdoom Ali Khan, a former Attorney General of Pakistan, disagreed with the majority's findings on jurisdiction and merits and issued a dissenting opinion.
Jurisdiction
In respect of issues of jurisdiction, the debate between the parties centred on whether Deutsche Bank had made a qualifying investment.
"Investment" under the BIT
The majority noted that the definition of the term "investment" under the BIT includes "every kind of asset". In particular, dismissing Sri Lanka's arguments, the tribunal reasoned that:
"the Hedging Agreement is an asset. It is a legal property with an economic value for Deutsche Bank. It is a claim to money which has been used to create an economic value" (Award, paragraph 285).
The majority further indicated that it did not consider that, under the BIT, claims to money must be associated with a separate investment.
In contrast, in his dissenting opinion, Mr Khan concluded that, for any claim to money to constitute an investment under the BIT, it must be:
- Used to create economic value.
- Associated with an investment.
Mr Khan concluded that the hedging agreement did not meet these requirements.
Sri Lanka also argued that the hedging agreement lacked a sufficient territorial nexus with Sri Lanka. Whilst the tribunal agreed that this is a requirement under the BIT, it dismissed this argument. Following the Decision on Jurisdiction and Admissibility in Abaclat v Argentina, ICSID Case No ARB/07/05 (see Legal update, Tribunal has jurisdiction over collective claim (ICSID)), the majority considered that, in respect of instruments of a pure financial nature, the existence of a territorial nexus is to be determined by considering the place where the funds are ultimately used. The majority concluded that the hedging agreement had a territorial nexus with Sri Lanka as "the preliminary engagement took place in Sri Lanka and it is there too that the investment had its impact" (Award, paragraph 291).
"Investment" in respect of Article 25 of the ICSID Convention
In respect of Article 25 of the ICSID Convention, the majority distanced itself from the application of the so-called Salini test. In this respect, the majority indicated that "there is […] no basis for a strict application in every case of the five criteria suggested by the Arbitral Tribunal in Fedax v Venezuela and restated (notably) in Salini v Morocco...[…]." The majority added that the Salini criteria "are not fixed or mandatory as a matter of law. They do not appear in the ICSID Convention." (Award, paragraph 294.)
The majority noted that "the development of case law suggests only three criteria […] namely contribution, risk and duration" (Award, paragraph 295). On the facts, the majority considered that the hedging agreement fulfilled these three criteria:
- Deutsche Bank had made a "substantial contribution" by committing, at the time of conclusion of the hedging agreement, to pay US$2.5 million if CPC's costs of importing oil remained above US$112.50 per barrel and made further payments after conclusion of this agreement.
- The hedging agreement entailed the risk on the part of Deutsche Bank to pay up to US$2.5 million to CPC.
- Duration is a flexible standard, which is dependent on the circumstances of the case. In this case, the majority considered that the duration requirement had been satisfied because the hedging agreement was to last 12 months, and Deutsche Bank had already spent two years negotiating the hedging agreement.
In his dissenting opinion, Mr Khan agreed with the majority that the fifth Salini criterion of regularity of profit and return is not required. However, he disagreed with the conclusion that the fourth criterion of "contribution to economic development" should be dispensed with. In his view, this was a typical characteristic of an investment. Applying these principles, he concluded that the hedging agreement did not qualify as an investment under Article 25 of the ICSID Convention.
Attribution
Deutsche Bank asserted that, in addition to the actions of the Central Bank and Supreme Court, CPC's actions amounted to a violation of the BIT. On the basis that CPC was wholly controlled by the Sri Lankan State, the majority concluded (obiter) that CPC could be considered an organ of the Sri Lankan State.
Merits
The majority accepted Deutsche Bank's claims and concluded that Sri Lanka had breached the FET standard in the BIT and its duty not to expropriate Deutsche Bank's investments. The dissenting arbitrator disagreed with these conclusions. In the light of its findings on FET, the majority considered that it was unnecessary to determine the claims based on breach of the duty to accord full protection and security or the umbrella clause.
FET standard
The majority concluded that the BIT provides for an autonomous standard (as opposed to a restatement of the minimum standard of treatment in customary international law). By issuing an interim order "without a proper examination and without giving the banks involved an opportunity to respond", the Supreme Court breached the FET standard "in a form of a due process violation" (Award, paragraph 478). The majority also held that the Central Bank's investigation and stop-payment order of 16 December 2008 amounted to a violation of the FET standard because the Sri Lankan Government acted in bad faith, there was a lack of transparency and due process in respect of this investigation and the Central Bank had acted in excess of its powers.
Expropriation
In this regard, the majority relied upon its findings on FET to conclude that the actions of the Supreme Court and the Central Bank amounted to "an expropriation of [Deutsche Bank]'s claim to debt under the Hedging Agreement" (Award, paragraph 520).
Quantum
The majority concluded that Deutsche Bank had "suffered a loss amounting to the sum that it would have received pursuant to the Hedging Agreement if there had not been breaches of the [BIT]" (Award, paragraph 572). The majority considered that the loss at the date of early termination of the hedging agreement amounted to US$60,368,993 and awarded this sum to Deutsche Bank by way of compensation.
Comment
The decision of the majority and the dissenting opinion are of particular relevance in respect of jurisdictional issues.
First, the findings of the majority show that, within the context of broad definitions of the term "investment" in a treaty ("every kind of asset" in this case), some arbitrators are prepared to consider that most types of rights and interests enjoy treaty protection, even if the rights or interests in issue do not feature the characteristics of an investment from an economic science viewpoint.
Second, the award and the dissenting opinion add to the ongoing debate as to the meaning of the term "investment" in Article 25 of the ICSID Convention. Both the majority and the dissenting arbitrator sought to find the meaning of the term "investment" within the confines of the ICSID Convention (the autonomous approach) without considering the definition of this term in the relevant BIT. Whilst the majority considered that the so-called Salini test is not mandatory, it resorted to it for guidance on the characteristics of an investment. This award is in line with other awards in which arbitral tribunals have considered the Salini test as a starting point in their analysis but have eliminated some of the original Salini requirements, in particular that of contribution to the host's state development (For other similar examples, see SociétéGénérale v Dominican Republic (LCIA Case UN 7927) and Saba Fakes v Turkey (ICSID Case No ARB/07/20) discussed in Legal update, ICSID tribunal redefines requirements for investment).